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.
- 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.
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.
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.
Originally Posted on July 23, 2021 – Income Outlook: Q2 2021 – Inflation Rising, but Bond Yields Falling
Index returns are for illustrative purposes only and do not represent actual fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indices are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
Shares of ETFs are bought and sold at market price (not NAV) and are not individually redeemed from the Fund. Brokerage commissions will reduce returns.
Investing involves risk, including possible loss of principal. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Bonds will decrease in value as interest rates rise. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments.
Real estate is highly sensitive to general and local economic conditions and developments, and characterized by intense competition and periodic overbuilding. Many real estate companies, including REITs, utilize leverage (and some may be highly leveraged), which increases risk and could adversely affect a real estate company’s operations and market value in periods of rising interest rates.
Investments in securities of MLPs involve risk that differ from investments in common stock including risks related to limited control and limited rights to vote on matters affecting the MLP. MLP common units and other equity securities can be affected by macro-economic and other factors affecting the stock market in general, expectations of interest rates, investor sentiment towards MLPs or the energy sector, changes in a particular issuer’s financial condition, or unfavorable or unanticipated poor performance of a particular issuer (in the case of MLPs, generally measured in terms of distributable cash flow).
MLPA has a different and more complex tax structure than traditional ETFs and investors should consider carefully the significant tax implications of an investment in the Fund. MLPA is taxed as a regular corporation for federal income tax purposes, which differs from most investment companies. Due to its investment in MLPs, the Fund will be obligated to pay applicable federal and state corporate income taxes on its taxable income, as opposed to most other investment companies. The Fund expects that a portion of the distributions it receives from MLPs may be treated as tax-deferred return of capital. The amount of taxes currently paid by the Fund will vary depending on the amount of income and gains derived from MLP interests and such taxes will reduce an investor’s return. The Fund will accrue deferred income taxes for any future tax liability associated certain MLP interests. Upon the sale of an MLP security, the Fund may be liable for previously deferred taxes which may increase expenses and lower the Fund’s NAV.
The potential tax benefits from investing in MLPs depend on them being treated as partnerships for federal income tax purposes. If the MLP is deemed to be a corporation then its income would be subject to federal taxation at the entity level, reducing the amount of cash available for distribution to the Fund which could result in a reduction of the Fund’s value.
Preferred stock is subject to many of the risks associated with debt securities, including interest rate risk. In addition, preferred stock may not pay a dividend, an issuer may suspend payment of dividends on preferred stock at any time, and in certain situations an issuer may call or redeem its preferred stock or convert it to common stock. High yielding stocks are often speculative, high-risk investments. These companies can be paying out more than they can support and may reduce their dividends or stop paying dividends at any time, which could have a material adverse effect on the stock price of these companies.
An option is a contract sold by one party to another that gives the buyer the right, but not the obligation, to buy (call) or sell (put) a stock at an agreed upon price within a certain period or on a specific date. A covered call option involves holding a long position in a particular asset and writing a call option on that same asset with the goal of realizing additional income from the option premium. By selling covered call options, the investor limits their opportunity to profit from an increase in the price of the underlying asset above the exercise price, but continue to bear the risk of a decline in the underlying asset. While the seller receives a premium for writing the call options, the price it realizes from the exercise of the option could be substantially below the investment’s current market price. These strategies may not be appropriate for all investors.
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