1st Quarter 2021
A long time ago (or maybe not that long ago), we had a contested Presidential election, where many had fears of a significant decline in market values if the result was a “Blue Wave”. Post-election, the market has not fallen, and it appears to be adjusting to a Biden Administration with Congress split between the Democratic and Republican parties.
During the quarter, there was substantial volatility in the markets. We started out with a strong equity market. Over the course of the quarter, the market volatility increased and we have had rallies and fails on an almost monthly basis. Yet, we end the quarter with the US equity market positive, even in the face of many cross currents and possible headwinds. We have seen a rotation out of technology stocks into “value” stocks. For investors who are more focused on growth please see attached First Trust analysis provided of growth vs value for a longer term perspective.
Some of the issues facing the US equity markets are concerns about the US economy, rising inflation, an increasing US deficit creating pressure on the US dollar, and an expectation of future tax increases. There are many pundits still calling for a correction in the major indexes. Others are supportive of the administration’s efforts to revive the economy through stimulus, and so far, the market seems to agree.
It is important to be aware that some investors and some sectors of the market have experienced negative results so far this year. While we have not experienced a broad market correction, as would be defined by a 15% decline in the S&P 500 Index this year, we have seen this level of decline in several of the market leaders from 2020.
Where last year’s returns were driven by high rates of growth in technology shares, this year many of these same stocks are lower on the year. On the other hand, the shares of companies representing businesses that are more traditional are up substantially this year, as investors have focused on the economy reopening. We have seen a rotation out of technology stocks into “value” stocks.
Looking forward, we have to stay aware of a wide variety of issues. As the Biden administration moves forward with its first year initiatives, there will be continued plans for stimulus and spending. This will continue to place pressure on the deficit, and is likely to continue to impact the value of the US dollar versus other currencies. This can become inflationary, a concern that many share. On the other hand, a weaker US dollar is generally good for exports. Furthermore, there is hope and expectation that the recent Covid stimulus will increase consumer spending, helping the economy reopen faster. A recently announced infrastructure stimulus plan could help job growth and the economy even further.
Some investors are concerned about the rate of change in the yield on the 10-year US Treasury bond, which has fallen in price as its yields have risen, peaking just above 1.75% this year. This has raised fears of an inflationary spike and its potential to disrupt the market’s climb. Our view is that a 10-year US Treasury at 1.75%, or even at 2.00%, is still a very low rate and unlikely to disrupt market appreciation. We need to be mindful of the rates on the 10-year US Treasury, as that will be a possible indicator of inflation, and should this rate change significantly, we would revisit this issue as a risk.
As the Biden administration moves forward with their spending plans, they will be challenged on developing ways to pay for their initiatives. During his campaign, Biden campaigned on higher corporate, individual, and estate taxes, and it appears that these will be introduced as a way to offset costs. While it remains to be seen what comes out of Congress, it is generally accepted that an increase in corporate taxes will negatively affect corporate earnings and that this may negatively affect stock valuations.
Investors need to determine how comfortable they are in light of these issues. While we remain bullish on US equities, we also continue to expect ongoing volatility as we work through these political and economic issues. It should come as no surprise that the high growth stocks of 2020 would have to “give some back” this year. It also should come as no surprise that “value” stocks would catch up, as the markets revert towards their historical averages. This is generally considered healthy, although can be painful if you are too heavily weighted on one side or the other.
We continue to believe that over the coming year, US equities will continue to provide moderate risk and attractive returns with a target of high, single-digit returns for the broader average of the S&P 500. It is our opinion that equity portfolios continue to be primarily invested in US equities with a focus on large cap companies. Some allocation to international growth and small-mid cap assets is appropriate for investors with a higher risk appetite.
Given the many issues, it is important to review your overall asset allocation and goals. It is also a good time to discuss your risk management strategy, should the unexpected happen. We cannot control the market, only try and anticipate its behavior, as we can control how we react. We look forward to reviewing your portfolio and discussing the markets in the coming weeks.
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Regards,
Elliot Weissmark, CFP®, CPFA
Senior Vice President, Investments
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