5 Insights on Inflation, Interest Rates and Taxes in Q2 2021

by James Liu, CFA / on April 1, 2021

As we begin the second quarter, it would be an understatement to say that investors have faced historic challenges over the past year. From the pandemic lockdowns to the sudden recovery, staying invested and maintaining a long-term view has been rewarded. During the first quarter, the S&P 500 gained 6.2% with dividends while the Dow rose 8.3%. This is true even though market and economic dynamics - and the resulting barrage of headlines - have made it difficult to feel comfortable with the bull market. Perhaps more than ever, investors need to stay disciplined on a number of challenging issues as this unique cycle evolves.

One year ago, the markets were hinged on the public health crisis as it spurred an economic crash, which in turn risked a credit crisis. Today, with the economy recovering and markets making new highs seemingly every week, the day-by-day state of the pandemic is less relevant to investors. Instead, attention has turned to the aftermath of the sharp crash and recovery: inflation, interest rates and taxes.

These are all challenges that will play out over the coming quarters, and there will no doubt be new issues that investors need to grapple with as the cycle continues. As is always the case, maintaining investment discipline by understanding these concerns with a broad, historical context, is the best way for investors to achieve their financial goals. Below are five charts that help to put these investor concerns in the right perspective.

1

The stock market continues to reach new highs

The market continues to grind higher despite a constant parade of investor concerns. In this environment, it’s more important than ever to stay invested while avoiding complacency.

2

Interest rates have risen across the board

Interest rates rose significantly during the first quarter and long-term rates could continue to increase as the recovery continues. The Fed has made it clear that they intend to keep short-term interest rates low, possibly until at least 2023. This could continue to steepen the yield curve in the coming quarters.

3

Inflation expectations are surging too

Prices in certain sectors and inflation expectations in the market are rising. While investors may not need to fear runaway inflation just yet, they should consider asset classes and sectors that may help to protect their portfolios.

4

Economic activity is accelerating

The economy is recovering well with some indicators of activity at their highest levels in decades. Unemployment continues to improve although many long-term unemployed in hard-hit sectors will need more time to get back on their feet.

5

Taxes could increase for individuals and corporations

Government spending and new proposals, including the infrastructure bill, may push taxes higher for both individuals and businesses. Investors should consider what this means for their portfolio construction and accounts. However, history shows that both the economy and markets can grow when taxes are both high and low if underlying fundamentals are sound.

The bottom line? Investors have faced many challenges over the past year and during the first quarter. There will no doubt be more market volatility in the quarters ahead. Investors ought to remain disciplined and consider the challenges of inflation, interest rates and taxes with a long-term perspective.

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