An Amazing First Half

It was quite a first half of the year for investors: meme stocks, cryptocurrency bubbles, inflation scares and the S&P 500 closed June 30 (LVM’s 33rd anniversary) at a record high. Stocks had one of the strongest first-half performances since 1998 (and in the top 5 since LVM began operation). The catalysts were better-than-expected economic growth and a strong earnings tailwind overcoming some interest rate headwind. Indeed, the rate on the 10-year Treasury Note declined in the second quarter after rising since last May.

The S&P 500 and S&P GSCI gauge of commodities have now both climbed at least 5% in five consecutive quarters for the first time in 50 years according to a Dow Jones Market Data analysis. And with returns from cash and bonds still limited due to ultralow interest rates—or even negative when factoring in inflation—investors keep favoring better performing investments.

Earnings reports for the second quarter start in a few weeks. Comparisons will be to a very weak quarter a year ago when the economy was shuttered. Consensus earnings estimates are for 60% growth versus last year and 11% higher than the same quarter in 2019. For now, the outlook is good. How long momentum can be sustained remains an open question.

A major concern is rising costs. The massive and unprecedented fiscal and monetary stimulus is producing monetary inflation compounded by big government interventions in the labor market. The US government has passed three record stimulus bills that cost a combined $4.8 trillion and handed out over 160 million stimulus checks. Now it is looking to approve new stimulus bills that could cost anywhere from $4 trillion to $6 trillion. Growth in money supply has surged 30% as the Federal Reserve’s stimulative monetary policy has increased money supply readily available at banks.

The Fed feels the current high inflation (5% year-over-year) is transitory and that inflation should dissipate in the months ahead as supply catches up with demand. Higher prices in the interim will bring more production while reducing demand. We will learn more from managements’ forward-looking statements as they release second quarter earnings.

Companies faced with rising costs will either take a hit to their profit margins or will raise their prices - if they can. Historically, stocks of quality companies which have growing free cash flow and high returns on invested capital have been good inflation pass-through vehicles. We continue to favor such companies in our research efforts.

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