We’ve come a long way on this pandemic. Over 50% of Americans have been either infected already by Covid or have received one vaccination shot. It shouldn’t be too long before the US hits the herd immunity level which could be as low as 60% or as high as 80+%. That’s great news for Americans and the prospects for a US economic recovery. High frequency economic activity data tells us that things continue to improve. For example, at one point TSA traveler traffic was down 96%, now its only off 39%. Hotel occupancy was down 69%; now only down 15%. Unemployment, which hit 14.8% last April, is now back down to 6%, which is lower than its 50-year average! In a few months, the US economy will be roaring at levels not seen in decades. These are truly exciting times, but what does all this mean for the markets…read on to find out… But first, let’s take a look at how the major asset classes fared in 1Q21:
Equities: Stock markets continued their yearlong ascent with the S&P500 up 6.2%, the MSCI AC World Index up 4.6%, and the MSCI AC World Index ex-USA (a good international proxy) up 3.5%. If you’re a frequent reader to our blogs, you know that we’ve talked a lot about rotation, i.e. the movement of money invested in one area to another, out of the big growth leaders of 2020 into more cyclical plays like small cap and value. Take a look at the chart below to see how value has outperformed growth and small cap has outperformed large in this latest quarter – it’s the reversal of what we saw for most of last year. Lastly, given that the stock market bottom was just over a year ago, it’s fun to take a look at the rolling one-year results - using the same benchmarks above that is: 56.4, 64.6%, 49.4%, respectively!
Fixed Income: US bonds, as represented by the Barclays US Aggregate Bond Index, just had their worst quarter in almost 40 years, down 3.4%! International bonds, represented by the Barclays Global Aggregate Bond Index, fared even worse, with a negative 4.5% showing! Recall that bond prices go down as yields go up, so when the 10-year Treasury goes from 0.9% to 1.7%, ugliness like that can happen. Which is why prudent fixed income management like keeping duration low and taking advantage of non-core fixed income areas like emerging bonds is so important.
Alternatives: Alternatives had a mixed quarter depending upon the actual strategy. After a really strong 2020, gold*, down 10.2% in 1Q21, saw many people taking profits as the “flight-to-safety” trade that made it so popular didn’t seem so necessary with the pandemic subsiding. On the flip side, after a tough 2020, real estate** bounced back, up a handsome 9.4%. For the record, the Wilshire Liquid Alternatives Index (“WLAI”), one of the alternatives proxies we follow, was up 2.2%.
This was a good quarter to point out the benefits of asset allocation. Great quarter for stocks, lousy quarter for bonds, and mixed for alternatives. Put them all together, and most diversified investors that have an allocation to all important areas should be up a few to several percentage points – an excellent start to the year! But can this good fortune continue?
It’s almost been a goldilocks environment for the stock market with low rates and constant stimulus. Biden just last month signed the $1.9Trillion Covid relief bill and is now working on a $2 Trillion infrastructure plan. The economy is already heating up, and with these measures, the fear is that it doesn’t overheat and boil over and cause rampant inflation. The Fed is trying to keep things under control by saying they won’t hike rates until 2024, but that’s easier said than done. By the way, to pay for some of that Infrastructure plan, the Biden administration is suggesting a rise in taxes at several levels. The good news is that the income tax proposal to move the highest bracket up to 39.6% on those making over $400K in there would only affect less than 2% of the wealthiest Americans. But there’s also a proposal to move corporate rates from 21% to 28% which would affects shareholders of all those companies that will see less profit and possibly dividend cuts – basically a “back door” tax that will affect all of us with investment portfolios.
In conclusion, with the first quarter in the books, those investors that have remained fully invested during the last year plus are feeling pretty good. They and their portfolios have made it almost through a full pandemic and they are most likely seeing their account balances near all-time highs. But we would be amiss not to remind people that the stock-market is forward-looking. In other words, it has spent the last year thinking ahead to the economic recovery that we are in the midst of. What happens when it starts looking past that recovery? It’s inevitable that this short-term growth must come back to normal levels. The euphoric goldilocks conditions – at least for the stock market – will no longer be there. There’s no rule that says that the stock market goes up because the economy is going up – remember that Wall Street is not Main Street. It’s time to get back to realistic expectations and be ready for what’s next. If you aren’t prepared for that, contact your friendly wealth manager to get you ready.
Peace to you and your families,
Brett M. Detterbeck, CFA, CFP®
DETTERBECK WEALTH MANAGEMENT
*represented by the iShares Gold Trust
**represented by SPDR® Dow Jones Global Real Estate ETF