Interest rates continued to be a dominant headline in Q2, as the yield on the 10-year treasury pulled a near 180 degree reversal from earlier in the year, declining by more than 25 bps. This came in stark contrast to 2021’s first quarter, where looming inflation concerns caused interest rates to spike by more than 80 bps. This resulted in, not only, a reversal in performance for fixed income assets, but a meaningful change in leadership away from lower duration* and more economically sensitive value stocks toward higher duration* growth names. At the end of the day, however, just about all major asset classes ended Q2 in the black, with the benchmark S&P 500 and Barclays Aggregate Bond indexes gaining +8.55% and +1.83%, respectively.
U.S. large cap growth stocks re-emerged as one of Q2’s top performing asset classes, after taking a back seat to value and small cap names for much of the prior 7 months (September 2020 through March 2021). On the quarter, investors saw the Russell 1000 Growth index advance by just shy of 12%, while its value counterpart gained just 5.21% and the Russell 2000 advanced by 4.29%. We can attribute this outperformance to the usual set of suspects, namely the FAANG+M stocks, which accounted for nearly half of the Russell 1000 Growth index’s quarterly gain. These names, along with most growth stocks for that matter, disproportionately benefitted from their heightened degree of interest rate sensitivity, as the yield on the 10-year treasury sank from a starting point of near 1.75% to 1.46% at quarter end.
Non-U.S. developed and emerging markets equities ended the quarter with a solid showing in absolute terms, both gaining just over 5% in U.S. dollars. These gains were aided by a slightly weaker USD, which declined for most of April and May over fears of higher inflation and a continuation of loose monetary and fiscal policy. Unfortunately, relative to U.S. markets, performance was held back by continued COVID-19 concerns overseas and a lack of progress on the vaccination front, particularly in the emerging world.
Lower interest rates and tighter credit spreads led to strong quarterly results for nearly all major fixed income asset classes, cash excluded. This marked a meaningful reversal from earlier in the year, where cash and high yield were the only areas of the bond market to provide investors with positive returns. Within U.S. markets, the strongest gains were seen out of the investment grade credit index (+3.32%), which carries a duration of over 8 years and benefited as spreads hit their lowest levels in more than a decade. Outside of the U.S., emerging markets local bonds gained 3.54%, benefitting from investors’ increased appetite for risk and weakness in the dollar.
Broad-basket commodities were once again a standout performer, gaining more than 13% on the quarter, as energy prices continued to surge higher. Unlike the prior quarter, gains were positive across all major commodity categories. This included gold, which saw price gains of over 3% on the quarter, benefitting from both inflation concerns and declining interest rates. Commodities also received a technical bounce during the quarter, as crude oil futures found themselves in backwardation for nearly all of 2021, meaning that nearer-term futures contracts were trading at a premium to contracts farther out on the curve.
Closed End Funds
Closed end funds saw strong gains in Q2, as falling interest rates, tightening credit spreads, and declining equity volatility all provided a performance tailwind. This resulted in a decline of more than 150 bps for the average fund in the universe. iCM’s Tactical Income Closed End (TICE) strategy benefited from this industry trend, gaining 6.40% on the quarter versus a return of just 4.13% for its blended index. Despite the decline in discounts, the TICE strategy is still finding ample opportunities within the closed end fund space, with a tactical allocation of 55% to CEFs and an average distribution yield just shy of 4%.
*Please refer to our social media/blog post, titled “Equity Duration – The Connection Between Stocks and Rates”, for more information on the concept of equity duration.
Monthly “Market Flash” is intended solely to report on various investment views held by Integrated Capital Management. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable, but should not be assumed to be accurate or complete. References to specific securities, asset classes and financial markets are for illustrative purposes only and do not constitute a solicitation, offer or recommendation to purchase or sell a security.
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TICE Blended Index comprised of 32% S&P 500/8% MSCI EAFE/38% Barclays Aggregate Bond/20% Barclays Municipal Bond/2% Cash