Q1 Market Commentary – April 26, 2021
The pandemic has sparked many changes that will be long-lasting. It seems likely that we will Zoom more than we conference call from now on, we will continue to get more stuff delivered, and hopefully we’ll continue to spend more time with our families than we did before. It also seems likely that we’re going to see a lasting period of more activist government.
James Medlock, a twitter commentator, recently got widespread note for his quip that, “The era of ‘the era of big government is over’ is over.’” He was referencing Bill Clinton’s famous line from his 1996 State of the Union address. It seems increasingly clear that we’re moving more toward more government involvement in our economy. Not only has the US already enacted over $5 trillion in stimulus to help the economy recover from COVID, but the US Congress is considering a very substantial infrastructure bill to follow it up with.
The proposed infrastructure bill goes well beyond roads, bridges, and rural WiFi and includes assistance for caregivers for the elderly, workforce development, and climate change initiatives. The forthcoming education bill is rumored to include free community college and pre-K education for all. These bills are very much in the spirit of being “here to help” – although it remains to be seen how much of the non-infrastructure components of the bills will be passed by the narrowest of Democratic majorities in the Senate.
So far, the economy and the markets have responded well to the injection of stimulus and the prospect of more government spending, with GDP, corporate earnings, and the stock market bouncing back sharply. The impact hasn’t even been fully felt yet. Personal savings has built up to multi-year highs as spending has been restrained due to the ongoing pandemic, and much of the stimulus (and all of the infrastructure bill) has not yet entered the economy.
Barring an unexpected downturn in the progress being made against COVID (or other as-yet unforeseen risks), 2021 is shaping up to be a year of strong economic growth by any measure, as pent-up stimulus, new government spending, and latent consumer demand combine to boost economic spending.
Stocks have been buoyed by strong corporate earnings growth, and high expectations for 2021. Factset estimates that corporate earnings for the fourth quarter of 2020 were higher than for the fourth quarter of 2019 (the last quarter before the pandemic started), which represents an extremely rapid recovery from the sharp decline in early 2020. As analysts look at the first quarter of 2021, they have been steadily and substantially increasing their estimates as the quarter went on, which shows that the recovery in earnings continues to run ahead of expectations.
Small cap stocks surged this quarter as confidence grew that the broad economy would stage a strong comeback in 2021. The Russell 2000 index of small company stocks had total returns of 12.7% in the first quarter, adding to strong gains from the fourth quarter. The Russell 1000 index of large company stocks had total returns of 5.9% to start the year. Value stocks outperformed growth stocks, as the Russell 1000 Value index (large company value stocks) returned 11.2%.
International stock returns were similar to US stock returns for the first quarter, with the MSCI EAFE International index total returning 3.5%, and the MSCI Emerging Market index returning 2.3%.
Bonds fell a bit as interest rates rose, and as the market started to anticipate higher levels of inflation. The aggregate bond index had negative returns of -3.4%. Other bond categories held in our portfolios did better, as inflation-protected bonds declined only -1.5%, and short term bonds and world bonds were closer to even, returning -0.6% and -0.4% respectively.
Corporate bonds continued to indicate a calming trend since the crisis. The riskiest high yield bonds started 2020 trading at just 3.5% higher than government treasuries and then spiked up to more than 10% higher in late March 2020, but now have come back down to just below the 3.5% level again.
The first quarter of 2021 saw a bit of a reversal of the trend in most commodities in 2020. The overall commodity index was up 13.6%. Energy prices rose after falling sharply during the crisis, and the price of a barrel of oil went from $48 at the start of the quarter to $59 by the end. Precious metals, which had done well in 2020, declined in the first quarter and the price of gold fell by over 10% in the quarter.
The US Dollar also reversed direction. The US Dollar Index had declined for most of 2020, but rose by just under 4% in the first quarter.
The criticisms of Biden’s ambitious agenda revolve around the legitimate concerns that we have little precedent by which to gauge the possible negative impact of introducing so much capital into our monetary system. The CARES Act by itself ($2.2T) was nearly three times the size of Obama’s American Recovery and Reinvestment Act of 2009 ($831B) in response to the financial crisis.
With so much money being added to the US economy, inflation fears have resurfaced. Google searches for the word “inflation” recently hit their highest point since 2008. To date, the market has certainly priced in higher expected inflation (as of quarter end, the market was expecting 2.5% inflation over the next five years), but the current expectation represents only a return to the 30-year historical average off of historical lows, not a significant inflationary spike.
We dismiss the fears of hyperinflation that are the province of breathless pundits, but legitimate academic fears of long-term, above-average inflation—or even worse, stagflation (high inflation and high unemployment, like in the early 1980’s)— are risks worth protecting against in our clients’ portfolios. In fact, our holding of Treasury Inflation Protected Securities has already proven to be a good counterweight to bond underperformance resulting from rising rates this year. As always, we recommend a strategically diversified portfolio to protect against unexpected risks, as well as to enable more consistent returns over time.