View/Download PDF version of Q1 Commentary (or read text below)

Fixed Income
Fixed income securities declined, in aggregate, during Q1 2021, as interest rates rose; bonds prices fall when rates increase. The 10-year treasury bond, the most widely referenced proxy for U.S. interest rates, has nearly doubled during the first three months of the year, from 0.95% to 1.65%. While the increase has been sharp and brisk, rates remain extremely low relative to historical standards. For perspective, in the near-decade leading up to the 2008 financial crisis, the 10-year government bond resided around 5%. Rates have remained structurally lower post-2009, but in the year or two pre-COVID, the 10-year was at 2-3%.

Low interest rates facilitate economic activity because they mean that it is cheap to borrow money. Borrowed money is used to finance businesses and personal expenditures, thereby buoying economic output. Moreover, fixed income represents the prime alternative to equities; low rates are less appealing than high rates, all else equal, to investors, and therefore, when rates are low, demand for – and therefore, the price of – equities tends to be elevated. The main risk to the low rate paradigm is inflation; should inflation materialize at a rate greater than that of current expectations, the Federal Reserve will likely hike rates. Higher rates curb inflation because it boosts the expected return on savings, thereby encouraging investors to park money away rather than spend it (and hasty spending is the driver of inflation). For now, inflation expectations remain moderate, around 2%; in turn, rates are likely to remain relatively low.

Equities
The S&P 500, Dow Jones Industrial Average, and Nasdaq 100 were up approximately 6%, 9%, and 3%, respectively, in the first three months of 2021. The Dow’s leadership – and the Nasdaq’s lag – are a reversal from 2020, during which time the tech-heavy Nasdaq outperformed the industrial-laden Dow. Clearly, in 2020, tech stocks benefitted from “stay-at-home” trends; in 2021, however, travel and leisure are set to uncoil as the American population gets vaccinated.

As touched on above, stocks are benefitting from an accommodative interest rate environment in which investor demand for fixed income is muted owed to low rates. On top of this, the tremendous volume of fiscal stimulus combined with reopening trends imply a highly favorable 2021 outlook for U.S. corporations.

Outlook
As of mid-April, between 25-30% of the U.S. population has been vaccinated. The pace of inoculation is highly encouraging and suggests that sometime during the summer, a great enough portion of Americans will be vaccinated such that “normalcy” – or something resembling it – will resume. Reflecting the pent-up demand that will be truly unleashed, economists believe U.S. GDP could be as high as 6% during 2021, the most productive economic year in America since the 1980’s. While equity valuations appear high relative to historical figures, the stock market is not expensive compared to fixed income, the more salient measure. As fiscal stimulus flows through the economy and amplifies the pent-up demand, corporate earnings are likely to increase meaningfully and support current stock prices. As discussed, the key risk facing financial markets is inflation, because high inflation would likely force rates up, hindering equity valuations. At this point, though, we note that inflation expectations remain moderate and therefore, inflation is unlikely to interfere with the near-term outlook.

by William Henderson, Vice President / Head of Investments
The market continued its hot streak with yet another week of positive gains across all three major indices. For the week that ended April 16, 2021, the Dow Jones Industrial Average returned +1.2%, the S&P 500 Index gained +1.4%, and the NASDAQ moved higher by +1.1%. Year-to-date gains moved higher as well, with the Dow Jones Industrial Average returning +12.3%, the S&P 500 Index +11.9% and the NASDAQ +9.2%. Strong demand from international investors for U.S. Treasuries pushed bond yields lower again even as the economy is exhibiting considerable evidence of a powerful rebound in 2021. The 10-year U.S. Treasury Bond closed the week at 1.58% down another eight basis points from the previous week.   

The past week’s gains were widespread with the market showing strength and breadth of performance across several industry sectors including healthcare, retail, and industrial names. Widespread gains across industry sectors is a sign that the market is healthy with strong participation by many companies and industries rather than just a few names. See the chart below from Cornerstone Macro showing the Breadth of the Market in terms of the percent of stocks in the S&P 500 above their 150-day moving average.

Evidence of the economic rebound was present in several places last week. According to Bloomberg, retails sales rose by 9.8% in March compared with February; this was the one of the largest paced gains in 30 years. The jump in sales was driven by consumer spending as stimulus checks continued to hit personal bank accounts. The more favorable news was that easing of COVID-19 lockdown restrictions and progress in vaccinations allowed consumers to resume their old spending habits. Spending was spread among many retail sectors such as clothing stores, motor vehicle sales, and restaurant and bars. 

The green shoots in consumer spending could be just the beginning of a spending juggernaut that will unfold as more sectors of the economy open and the vaccination rate increases. The U.S. personal saving rate, as reported by the Federal Reserve Bank of St. Louis, currently 14%, stands nearly twice its pre-pandemic level of 8%. If consumers simply reduce their savings to the former level and resume historic spending patterns a strong economic rebound is on the near horizon.  

Lastly, corporate earnings releases for the first quarter of 2021 began last week with several major banks reporting their first-quarter results. According to Bloomberg, profits for all 13 major banks easily exceeded Wall Street analysts’ expectations, driven by lower credit costs, active trading, and investment banking activity. Banking is the backbone of economic activity as lending to companies allows for growth and investment. Federal Reserve Chairman Jay Powell is committed to keeping rates low for as long as necessary to force an economic recovery. Low rates allow banks to borrow low and lend high – a simple equation for success and growth.

Low rates, consumers flush with cash, and widespread COVID-19 vaccine distribution continue to propel the economic recovery. The breadth of the recovery among economic sectors and across equity markets is pointing to the next phase of our economy when we move from recovery to expansion.