The S&P 500 Index climbed 6.2% over the first quarter of 2021. Value stocks outpaced growth stocks, and small-cap stocks bested large-cap stocks. Overseas, the MSCI EAFE Index rose 3.5%, and the MSCI Emerging Markets Index added 2.3%. In fixed income markets, the Bloomberg Barclays U.S. Aggregate Index fell 3.4%, as the yields on U.S. Treasury bonds rose significantly. In economic news, U.S. gross domestic product (GDP) increased at an annualized rate of 4.3% in the fourth quarter of 2020 and is forecast to increase 6.5% over 2021.
The S&P 500 Index rose 6.2% over the first three months of the year. All 11 underlying sectors of the S&P 500 posted positive returns for the quarter. Since losing a third of its value in 2020, the energy sector has come roaring back in 2021. The sector jumped 30.9% over the first quarter of the year, largely rising in tandem with oil prices. The best-performing sector of 2020, information technology, has fallen back to earth in the opening months of the new year, rising just 2% so far. By contrast, in 2020, information technology rose 43.9%. The fortunes of the energy and information-technology sectors are reflective of broader movements in the market. Namely, investors have rotated out of stay-at-home stocks, and into stocks that stand to benefit from the reopening of the economy. Investors have begun emphasizing cyclical value stocks, which tend to outperform when economic growth accelerates above-trend. In the first three months of the year, the large-cap Russell 1000 Growth Index rose 0.9%. The large-cap Russell 1000 Value Index, on the other hand, rose 11.3%. Value stocks have outpaced growth stocks across all market capitalizations, and small-cap stocks have bested large-cap stocks. Small cap stocks benefit more from domestic growth rather than large caps which contributed to the strong relative performance.
International stocks delivered muted returns relative to their domestic peers. The MSCI EAFE Index of international developed markets rose 3.5%. In local currency terms, the EAFE Index was up 7.6%, but a 4% decline in the EU currency reduced performance for U.S. investors. Outside of the United Kingdom, Europe and Japan have lagged the U.S. in the vaccination rollout and this has slowed the economic recovery and dampened equity returns. The MSCI Emerging Markets Index rose 2.3%. China, which represents the largest weighting within the Index, hampered returns after declining 0.4%. Information-technology giants, most notably Alibaba, have recently come under scrutiny from Chinese regulators that are concerned that these companies are becoming too influential. Making matters worse, the U.S. Securities and Exchange Commission adopted the Holding Foreign Companies Accountable Act in March and U.S. listed Chinese stocks, including Alibaba, Baidu, and JD.com, fell sharply. International companies face potential delisting if they are determined to be controlled or owned by a foreign government.
The Bloomberg Barclays U.S. Aggregate Index dropped 3.4% for the quarter, while the broader Bloomberg Barclays U.S. Universal Index dropped 3.1%. The yield on the 10-year U.S. Treasury nearly doubled over the first three months of the year, beginning the quarter at 0.93% and ending at 1.74%. An inverse relationship exists between bond prices and bond yields; as bond prices decrease, bond yields increase. The yield on the 10-year U.S. Treasury had not surpassed 1.5% since February 2020. At least a couple of factors contributed to the rise in yields. For one, investors expect that strong economic growth fueled by government stimulus may lead to higher inflation that forces the Federal Reserve to raise interest rates. In addition, the increased supply of Treasuries resulting from additional government borrowing has tested investors’ appetite for bonds.
The rise in the yield of the 10-year U.S. Treasury also had ramifications for stocks. The 10-year U.S. Treasury yield is often used as a discount rate by investors valuing stocks, and rising yields weigh on growth stocks that are forecast to make a greater proportion of their earnings in future years. Very few corners of the fixed-income market saw positive results for the quarter. That said, high-yield bonds and bank loans respectively rose 0.9% and 1.8% during the quarter. These bonds started with higher yields and this helped dampen the impact of rising interest rates.
In March, the Federal Reserve estimated U.S. GDP will grow 6.5% in 2021. Just three months prior, the Fed estimated U.S. GDP would grow 4.2% for the year. Most of the upgrade in growth was the result of a successful vaccination program. President Biden targeted 100 million vaccinations in his first 100 days, but this figure quickly increased to 200 million after a successful launch. Most economists predicted the U.S. economy would fully open by year-end. However, this date has been moved up several months and a handful of states are fully open with minimal if any Covid-19 related restrictions.
In mid-March, President Biden signed a sweeping $1.9 trillion stimulus bill known as the American Rescue Plan (ARP) into law. Most notably, the ARP provides $1,400 one-time, direct payments to individuals making less than $75,000 and married couples making less than $150,000. Similarly, the ARP extends a supplemental $300 weekly benefit for the unemployed through Labor Day and provides $350 billion in aid to state and local governments. The stimulus helped boost growth prospects and contributed to the Fed’s revised growth outlook.
After peaking at an all-time high of 14.8% in April 2020, the unemployment rate has gradually normalized. In December 2020, the unemployment rate stood at 6.7%. By March 2021, the unemployment rate had ticked down to 6%. The Fed estimates the unemployment rate will fall to 4.5% by the close of 2021 as the economy fully reopens.
Despite some initial hiccups, COVID-19 vaccine distribution within the U.S. has gone quite well relative to the rest of the world. Nearly 40% of the population in the U.S. has received at least one dose of a COVID-19 vaccine. By comparison, less than 7% of the world population has received at least one dose. To date, over 25% of the U.S. has been fully vaccinated against COVID-19. Worldwide, this figure is still below 3%.
In part due to positive vaccine developments, economic growth within the U.S. is forecast to rise at a rapid rate in 2021. The Fed estimates U.S. GDP will grow 6.5% for the year, the highest growth rate for the economy since 1984. Other prognosticators see even higher growth. Goldman Sachs, for example, predicts U.S. GDP will grow 8% for the year.
Rapidly rising inflation expectations pushed longer dated bond yields higher during the quarter. However, barring faster than expected growth it is unlikely that interest rates will rise as quickly in the months ahead. Nonetheless, most investment grade bond yields are still below the Fed’s 2% inflation target, making bonds an unattractive investment, especially as economic growth rapidly advances. Credit spreads are at all-time lows so taking on additional credit risk presents additional default risk with minimal incremental return potential. Bond returns will be muted and potentially negative as the economic recovery advances, and they offer little downside protection given their low absolute yields.
Robust economic growth, an impressive vaccine rollout, and a low interest-rate environment all represent tailwinds for domestic stocks. While 2020 was dominated by information technology and consumer discretionary stocks, the opening months of the year have seen cyclical sectors like energy and financials rise to the top. The rotation into value stocks that unfolded in the final quarter of 2020 has carried on into the opening months of 2021. Likewise, small-cap stocks continue to outpace large-cap stocks, a trend that began over the final months of 2020.
Investors were predicting an economic recovery and consequently stock prices moved higher in the last nine months of 2020. Thus far, the recovery has been more robust than many predicted and domestic stock prices, particularly cyclical value stocks, have additional room to grow as the economy recovers. That said, diversification should not be forgotten. Although the S&P 500 has outperformed developed and emerging markets to begin the year, valuations remain attractive overseas, particularly for the latter. Markets are forward looking and any positive developments on the vaccine front overseas could boost returns, particularly given the larger relative percentage of cyclical stocks.
Meet the Expert
Partner + Chief Investment Officer
Darin Richards, CFA®
Aldrich Wealth LP
Darin joined the Portland wealth management firm in 2004, bringing more than a decade of investment and financial consulting experience with him. As chief investment officer for Aldrich Wealth, Darin is responsible for developing, and implementing our investment philosophy and leading the investment committee. He works directly with some of our most complex and largest clients and also…
- Series 7 and 63 security exams
- Chartered Financial Analyst (CFA®)