Considering the strong returns in the first half of 2021, we will provide our thoughts on the second half. Obviously, we cannot predict the markets; however, we can use some statistical analysis to shape a thesis and probabilities. Usually, market strength begets strength and most of the studies confirm this. That is bullish for the second half of the year. We will look at two studies: one that confirms that bias and one that differs. For a bullish tone, a study by one of our favorites, Ryan Detrick, shows that when the S&P 500 is up greater than 12.5% year to date at the end of June, the next six months are up a median of 9.7% which is twice the median final six months for all years.
If we want to pump the breaks on optimism, we know that the third quarter is the most challenging during the year with August and September being some of the worst trading months. A recent study from Nautilus Capital provides a contrast to the recent strong upside momentum presented above, writing “#SP500 first half year to date momentum "IS" typically a good indication of continuing rest of year momentum (no revelation there as many technicians; including us monitor this closely.) In contrast, the study below offers an interesting "twist" on potentially excess momentum....”
This study certainly paints a different picture than the normal strength begets strength argument. Another study shows the one-year rolling correlation of the Nasdaq 100 against the ten-year treasury yield. This is simply another valuation metric that shows that the index is historically extended. The question is whether the future is based on the 2000 and 2007 precedent or more like the mid-90s and 2017-time frame. Clearly the outcomes are incredibly different with the former leading to devastating bear markets and the later just a continuation of a secular bull market.
As we look to the second half, the most important consideration from a macro stance will be the direction of interest rates and yields. The language from the Fed will determine most of that action and their decision to taper, raise rates, or do nothing will be the most important discussion. Every statement or comment will be combed through in fine detail looking for the smallest of nuances. Yet, after a tough first half for growth equities, we could see a sustained rotation out of value and back into growth if rates subside. A recent tweet from Jurrien Timmer sums this up, “with peak reopening and peak inflation likely behind us, I expect some ongoing counter rotation from growth stocks.”
We expect the inflation debate will continue in the back half of the year. Additionally, there will be ruminations about the pace of economic growth, which is certain to decelerate from the torrid pace seen in the first half of the year. The Fed will be central as they attempt to shift policy and dance around concerns over peak growth, Delta variant, and inflation.
We still believe the market remains in a secular bull market and the future remains very bright for growth equities as the technological revolution continues even after a tough first half. As active managers, our smaller size allows us the flexibility to change our exposure levels with more ease, which is critical for extracting alpha for our partners. We believe our methodology protects our partners’ capital through various cycles.
