Quarterly Update

Market performance during the first quarter (Q1) of 2021 is probably best summed up as a transitional phase. We began anew after what was, on balance, a horrendous year for public health and much of our economy. Then increased vaccinations, more relief from Congress, and further reopening across the country helped signal a shift toward a more positive future. Stock investors reacted favorably to this while bond investors were cautious.

The stock market remained solid throughout the quarter as it threw aside performance trends from last year. Small company stocks and various market sectors had underperformed for much of 2020 but a rotation between them, which began late last year, continued into Q1. The result was that small company stocks enjoyed a big runup through about mid-March and handily outperformed their large-cap brethren. Not all returns were positive, however. The bond market struggled as investors digested a seeming disconnect between sanguine inflation guidance from the Federal Reserve and the massive amounts of relief and stimulus money coming from Congress.

Here’s a roundup of how major markets performed during the first quarter:

• US Large Cap Stocks: up 6.4%
• US Small Cap Stocks: up 12.9%
• US Core Bonds: down 2.7%
• Developed Foreign Markets: up 3.9%
• Emerging Markets: up 2.4%

Style (e.g. small vs large company) and sector (e.g. energy vs technology) rotation was a main theme during Q1. Some analysts suggested the rotation may have been due to large scale portfolio rebalancing after such a lopsided year as 2020. Whatever the reason, and there were probably many, the performance difference during Q1 was stark when compared to last year. The smallest company stocks that had seen a horrible 2020 were up almost 24% and the largest that had performed so well last year were up a relatively small 6%. Within the various sectors, Energy was the clear outperformer during Q1, up 31%, while Technology, a market darling in 2020, was up only 2%. All told, the S&P 500, the typical measure of the US stock market, closed at an all-time high of 4,000 as the quarter ended.

The transition from a market focused on stay-at-home orders to a more optimistic reopening trend was clear throughout the quarter. This had a negative effect on the bond market, however. Bond investors saw one of their worst quarters since the Global Financial Crisis. The yield on the benchmark 10yr Treasury ended the quarter at about 1.7%, up from early-pandemic lows of half a percent and .9% as 2020 ended. Since bond prices move in the opposite direction of yields, this steep increase in yield led to steep price declines. And the longer the term, the worse the performance. 20+ year Treasuries were down 13%. Intermediate-term Treasurys, the kind more typical to investor portfolios, were down 3-4%.

This transition phase for bonds seemed almost entirely due to the inflation fears of investors here and abroad in countries like Japan. However, those controlling interest rate policy and government spending weren’t (and still aren’t) nearly as concerned. Even though the government seems poised to inject trillions into the economy from the start of the pandemic and over the next several years, Fed Chair Jerome Powell and Treasury Secretary Janet Yellen don’t expect inflation to be a problem. Both speak of the pandemic creating a huge economic hole that we’re still digging our way out of and how stimulus from Congress and work by the Fed are providing backfill. Some excess inflation will even be welcomed, they suggest, as the recovery is allowed time to reach more Americans.

We learned at the end of Q1 that our unemployment rate dropped to 6%, down from almost 15% a year ago. While this should be celebrated, there are still roughly 4 million more unemployed Americans than before Covid. And millions more are either working part-time because their hours have been cut and others are simply detached from the workforce. Additionally, the number of so-called long-term unemployed is stuck at over 4 million people, up substantially from before the pandemic. Powell and Yellen have said they won’t be concerned about inflation until most of these people are back to work. This is expected to take at least a couple years, so money should be cheap and plentiful until then.

Even with all the current challenges and those yet to come, the outlook is brightening (we’ll put our hopeful hats on for a moment). Consumer confidence is higher, housing prices are soaring, the vaccine rollout is moving forward, people seem ready to travel again, and the recently passed $2 trillion American Rescue Plan may be followed by a $2+ trillion infrastructure plan. All this spending will boost the economy for most Americans and should help keep the stock market elevated for a while.

Obviously, there’s lots of risk to this outlook. Nothing is free and no government can spend aggressively for long without creating imbalances (aka bubbles), having to raise taxes, fight inflation, or all three. The stock market will eventually correct because of this and who knows what else, and bond prices will remain in flux as investors sort all this out. But again, the overall situation is showing signs of meaningful improvement. Accordingly, we’ll want to remain focused on fundamentals like diversification and rebalancing as inevitable shifts occur within our portfolios.

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