The promise of an efficacious vaccine began to materialize in the second quarter as US markets continued to perform, economic activity accelerated, jobs returned, and overall sentiment remained high. However, relatively higher inflation induced partly by supply constraints, and expectations of higher rates, dampened what has otherwise been a quick recovery from the pandemic-driven recession last year. U.S. equity benchmarks finished the second quarter at or near record highs, notching impressive gains for the first half of 2021, thanks to a strong tailwind from historic fiscal and monetary stimulus.
After stumbling out of the gate in January, the S&P 500 Index posted five consecutive monthly gains, finishing the first half of 2021 with a total return of 15.2%. The Russell 1000 Value Index (16.9%) outperformed the Russell 1000 Growth Index (13%) by 3.9% in the first half 2021 but Value’s lead may not last. Growth staged a late quarter comeback and outperformed Value by 6.1% thanks to a more hawkish Federal Reserve at the June Federal Open Market Committee (FOMC). Small and micro-caps posted the largest gains for the first half of the year, with the Russell Microcap Index returning 29% followed by the S&P 400 Midcap Index, which returned 17.6%.
Second-Quarter 2021 Performance Highlights
- The Thornburg U.S Equity Strategy posted a total return of 5.59%, net of fees, during the quarter, trailing the S&P 500 Index which posted a total return of 8.55%. Despite the near-term underperformance, over the previous 1-year period the U.S. Equity Strategy has returned 41.11%, net of fees, slightly ahead of the S&P 500 Index which has returned 40.79%.
- During the quarter, the performance of the Thornburg U.S. Equity Strategy was driven by strong absolute returns in communication services, financials and energy sectors. Stock selection within those sectors was the primary driver of relative performance versus the benchmark.
- The underperformance during the quarter was driven by the health care, information technology, consumer discretionary and consumer staples sectors. Within those areas, stock selection was the driving force of the underperformance, with half of the total coming from the health care sector alone.
Current Positioning and Outlook
The economy still seems to be in the early recovery stages of the cycle following the lockdowninduced recession, but there are risks and mixed signals being given off by the markets. There is plenty of debate about how those concerns will unfold, but it seems the market has shifted its focus to the strength of the growth rebound, the implications for inflation, and the timing of central bank moves to taper asset purchases and eventually raise interest rates. U.S. equity benchmarks finished the quarter hovering around record highs, but those results were driven by fewer and fewer stocks. The S&P 500 Index set record highs in June and did so with only 4% of the companies in the index setting new highs.
The recovery has lead asset classes that performed poorly during the lockdown to become the winners in the post-vaccine phase, but as we move away from early cycle to mid-cycle, we expect that to change. We anticipate strong economic growth in the U.S. through the second half of the year with GDP growth that could be the best since 1984. Inflation should show signs of easing as demand begins to moderate and supply bottlenecks lessen. This should release inflationary pressures in the near term, but an upward pressure on wage growth could be a sign of its resurgence.
While the late quarter rotation towards higher quality growth stocks and away from value names hurt performance, the balance struck in the portfolio has produced solid results over the last year. As the market recovery matures and moves into mid-cycle, we believe higher quality stocks will benefit in that type of environment. Also, a more balanced market environment will emerge that is less about style and more about longer term earnings potential which plays to our strengths. Our continual focus on companies with strong free cash flow prospects and responsible capital allocation should allow us to deliver solid results.
Thank for your continued support and for investing alongside us.