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Market Review: Equity market strength continued through the second quarter as the Standard and Poor’s 500 stock index advanced 8.4%. The Index has now posted a gain of 5% or greater for five consecutive quarters for the first time in nearly 70 years. The Russell 2000 Small Cap Index returned 4.3%. This relative underperformance follows the best back-to-back quarters for small caps versus large caps on record. The MSCI All Country ex-US Index, the comprehensive benchmark for international markets, gained 5.5%. After experiencing the worst quarter since 1981, the Barclay’s Aggregate Bond Index rose 1.8%. Gold was up 3.3% and the Bloomberg Commodities Index rallied 13.3%. It was a quarter where virtually every category posted a positive return.

Rates and Rotation: While the S&P 500 has continued to placidly make new highs on the surface, the market has recently experienced sharp short-term rotations across industries and styles which has dropped statistical correlations between stocks toward historic lows. This may mean that the lack of viable alternatives to equities has led investors to quickly move within equities to alter risk profiles. The noteworthy event was the mid-quarter fade of the reflation (reopening) trade. Long-term Treasury rates bucked the consensus view by suddenly declining through quarter-end despite GDP running at a 9%+ annual rate and May’s Personal Consumption Expenditures inflation index jumping 3.4%, the largest increase since the early 1990’s. Following the well-worn playbook, mega-cap technology companies grabbed the baton and rallied as small caps, financials, and cyclically sensitive companies weakened. For the quarter, the iShares Russell 1000 Growth ETF (Apple, Microsoft, Amazon, Facebook….) gained 11.8% while the DFA Large Cap Value Fund (JP Morgan, Comcast, Pfizer, CVS Health…) returned 5.2%. Year to date, DFA still holds a 20.7% to 12.9% performance advantage.

Fed Still Supportive: The S&P 500’s consistent advance has been driven by the sharp recovery of corporate earnings. Yardeni Research notes that the S&P 500’s forward price-to-earnings ratio of 22 is virtually the same level as one year ago. It is significant the market is no more richly valued after a 40% gain; however, the ratio is nevertheless historically quite high and remains dependent on the Federal Reserve’s zero interest rate policy and bond market intervention. Equities are being supported by the continuation of emergency policies during what appears to be a non-emergency environment. In fact, the Fed is buying $40 billion in mortgage-backed bonds every month while U.S. house price gains are at their highest for over thirty years. The Fed’s balance sheet has doubled to over $8 trillion in the last two years and the Fed is overdue to signal a less accommodative policy. An announcement to that effect could follow their Jackson Hole meetings in late August. Given the generally full valuations, bullishness, and record margin balances, we continue to believe there remains the potential for considerable volatility when the Fed begins to reverse course. We remain diversified across both growth and value factors, are incremental buyers of overseas markets, and continue to hold a margin of safety through cash, short- term bonds, and inflation hedges such as gold.

We thank you for your trust and, as always, we welcome a detailed discussion of your investments.