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The US economy soared during the quarter: Real GDP rose at a 6.4% quarter-over-quarter annualized rate, and weekly initial unemployment claims are now closer to pre-pandemic levels. The overall unemployment rate declined to 5.8% in May. Nonfarm payrolls increased by 559,000 in May, following a disappointing increase in April that seemed to confuse the stock market. The Conference Board’s Leading Economic Index increased in April and May, following modest results in January and February. Corporate margins reached all-time highs, and S&P 500 companies easily beat bottom-line analyst estimates to record the largest upside surprise in more than ten years.

Inflation has been one of the most widely discussed topics in the financial markets this year. In this quarter’s Key Investment Perspectives, we take a closer look at the prospects for inflation given recent increases in inflation and analyze the concept of expected inflation versus unexpected inflation. Importantly, we also review actions that investors may take to mitigate inflation risks.

Key Takeaways

  • Equities: US equities continued their strong start to the year, posting a gain for the second quarter of 8.2% to bring the year-to-date (YTD) gain to 15.1%. Large cap securities returned 8.5% (15.0% YTD) while small cap securities returned 4.3% (17.5% YTD). International equity markets have been more volatile than US equity markets. Developed ex-US markets were up 5.7% — almost on par with the US — while emerging markets experienced similar positive returns, gaining 5.7% also.
  • Fixed Income: The Bloomberg Barclay’s Aggregate Bond Index returned 1.8% during the quarter, while corporate bonds returned almost twice as much, rising 3.5%. YTD, however, both returns are still negative, given the declines during the first quarter. Ten-year US Treasuries rose 1.7% during the quarter, with the shorter end of the yield curve relatively unchanged and the long end posting strong returns. The US High Yield Corporate Bond Index has risen 3.6% this year.
  • Tactical Asset Allocation: Key Private Bank’s Dynamic Allocation Research Tool (DART) continues to favor stocks relative to bonds based on positive readings within the three main pillars of the model: macroeconomic factors, investor psychology, and corporate fundamentals. At the beginning of this year, we lowered our overweight to US equity as we sought to increase cyclical exposure in overseas equity markets. The stance continues to be appropriate. We also introduced an allocation to a diversified portfolio of real assets, including real estate, precious metals, and listed infrastructure. Within fixed income, we emphasize investment-grade, credit-oriented sectors over Treasuries and government debt. We also emphasize alternative strategies for appropriate investors.