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Income Outlook: Q2 2021 – Inflation Rising, but Bond Yields Falling

Global X ETFs

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Global X ETFs
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Research Analyst

The Global X Income Outlook for Q2 2021 can be viewed here. This report seeks to provide macro-level data and insights across several income-oriented asset classes and strategies.

Key Takeaways:

  • Inflation accelerated in Q2, amid re-opening exuberance and disrupted supply chains
  • The Federal Reserve’s May meeting acknowledged inflationary pressures and potentially more hawkish policy in 2022-2023
  • Long term bond yields have plummeted and Growth has resumed its leadership over Value, signaling that the market is less concerned about persistent, structural inflation
  • In a low yield environment with potentially rising rates in the next 1-2 years, we favor real assets like MLPs and REITs that offer high yields and the potential to pass through inflationary pressures to their customers
  • Covered call strategies may also help generate income in volatile markets as inflation data is noisy

Inflation Accelerated in Q2

Last quarter we discussed the looming reflation in Q2, and that thesis certainly came to fruition based on headline numbers. Year over year (YoY) the Consumer Price Index (CPI) rose 4.2% in April, 5.0% in May, and 5.4% in June.1 The numbers may seem staggering for the United States economy at first glance, but it’s important to consider the context. A year ago, Q2 2020, represented the depths of the pandemic in the U.S. and most of the western world. Swift re-opening progress in Q1-Q2 2021, due to effective vaccine distribution, has helped accelerate the economic recovery, causing abrupt pressure on supply chains and unusual comparisons with year-old data points.

Closer examination of the inflation data for Q2 shows that inflation may be concentrated within certain segments. In June, used car prices were up 45.2% and energy prices increased 24.5% YoY.2 Used cars are a 3.2% weight in the CPI basket, and energy is a 7.1% weight.3

More critical to the inflation equation, however, is whether strong consumption persists and if supply chains can operate more consistently and efficiently. On the consumption side, the latest retail sales numbers from June showed only an 0.6% increase for the month. Fading re-opening enthusiasm or the drying up of government stimulus checks could be factors in the sluggish growth numbers compared to prior month. In addition, a broader consumer shift from goods to services may be partly to blame as well. Furniture sales fell -3.6% in June for example, but bar and restaurant sales increased 2.3% for the month. The latest PCE Services Index numbers from May finished up 0.7% compared to a -1.3% decline in the PCE Goods Index.4 Services inflation is fueled by re-opening enthusiasm, while goods inflation may stem primarily from supply chain challenges.

Supply side pressures are unlikely to abate for the rest of the year based on continued labor shortages, just-in-case purchasing of goods, and concerns around the spread of the delta variant. Both in the US and China, the world’s two largest economies, producer prices sharply increased in Q2 due to these challenges. Beijing was even so concerned about rising prices in the metals market that the government released some of its strategic reserves to increase supply and pressured manufacturers to avoid unnecessary purchases.

us and china ppi continued their rise in q2 2021

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FOOTNOTES

DEFINITIONS

S&P 500 Information Technology Sector GICS Level 1 Index: The Index comprises those companies included in the S&P500 that are members of the Global Industry Classification Standard (GICS) Information Technology sector. These companies include software & services, technology hardware & equipment, and industry group that make up the Information Technology sector.

S&P 500 Consumer Discretionary Sector GICS Level 1 Index: The Index comprises those companies included in the S&P500 that are members of the Global Industry Classification Standard (GICS) Consumer Discretionary sector. These companies include automobile & components, consumer durables & apparel, consumer services and retailing.

S&P 500 Consumer Staples Sector GICS Level 1 Index: The Index comprises those companies included in the S&P500 that are members of the Global Industry Classification Standard (GICS) Consumer Staple sector. These companies include food & staples retailing, food, beverage & tobacco, household & personal products

S&P 500 Real Estate Sector GICS Level 1 Index: The Index comprises those companies included in the S&P500 that are members of the Global Industry Classification Standard (GICS) Real Estate sector. These companies include equity real estate investment trusts and real estate management & development.

S&P 500 Communication Sector GICS Level 1 Index: The Index comprises those companies included in the S&P500 that are members of the Global Industry Classification Standard (GICS) Communication sector. These companies include telecommunication services and media & entertainment.

S&P 500 Utilities Sector GICS Level 1 Index: The Index comprises those companies included in the S&P500 that are members of the Global Industry Classification Standard (GICS) Utilities sector. These companies include electric utilities, gas utilities, water utilities, independent power and renewable electricity producer.

S&P 500 Health Care Sector GICS Level 1 Index: The Index comprises those companies included in the S&P500 that are members of the Global Industry Classification Standard (GICS) Health care sector. These companies include health care equipment & services, pharmaceuticals, biotechnology and life sciences.

S&P 500 Materials Sector GICS Level 1 Index: The Index comprises those companies included in the S&P500 that are members of the Global Industry Classification Standard (GICS) Materials sector. These companies include chemicals, construction materials, containers & packaging, metals &mining, and paper & forest products companies.

S&P 500 Industrials Sector GICS Level 1 Index: The Index comprises those companies included in the S&P500 that are members of the Global Industry Classification Standard (GICS) Industrials sector. These companies include capital goods, commercial & professional services and transportation.

S&P 500 Energy Sector GICS Level 1 Index: The Index comprises those companies included in the S&P500 that are members of the Global Industry Classification Standard (GICS) Energy sector. These companies include energy equipment & services, oil, gas, & consumable fuels.

S&P 500 Financials Sector GICS Level 1 Index: The Index comprises those companies included in the S&P500 that are members of the Global Industry Classification Standard (GICS) Financials sector. These companies include banks, diversified financials, and insurance.

FTSE NAREIT All Equity REITS Index: A free float adjusted market capitalization weighted index that includes all tax qualified equity REITs listed in the NYSE, AMEX, and NASDAQ National Market.

Solactive MLP & Energy Infrastructure Index: The Solactive MLP & Energy Infrastructure Index tracks the performance of MLPs and energy infrastructure corporations.

Bloomberg Barclays EM USD Aggregate Total Return Index: A flagship hard currency Emerging Markets debt benchmark that includes fixed and floating-rate USD dollar-denominated debt issued from sovereign, quasi-sovereign, and corporate EM issuers.

Endnotes:

1. Bureau of Labor Statistics. Data for April to June 2021.

2. Bureau of Labor Statistics. Data for June 2021.

3. Bureau of Labor Statistics.

4. Bloomberg.

Originally Posted on July 23, 2021 – Income Outlook: Q2 2021 – Inflation Rising, but Bond Yields Falling

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