QUARTERLY MARKET UPDATE as of April 2021
The first quarter was another strong one for the stock market with the S & P 500 up over 6%. All sectors were in positive territory as the economy continues to open up and stimulus money provides a tailwind. The Energy and Financial sectors again led the way, both showing very strong gains after lagging last year. Investors are shifting their allocations towards cyclicals and value and away from momentum stocks as interest rate rise. International stocks also had solid returns gaining 4%, while Small Cap stocks surged, with the Russell 2000 small cap index increasing over 12% for the quarter.
The mid and longer end of the yield curve has shifted upwards. The 10-year Treasury started the year at 0.90% and is now up to 1.73%, still low by historical standards, but moving back to more normalized levels. We expect to see the 10-year rate above 2% by the fall. All rates about the 2-year maturity increased in the first quarter. Short term rates which are more controlled by the actions of the Federal Reserve Bank will remain low.
At its two-day meeting in March, the Federal Reserve unanimously agreed to keep its easy money policy in place until the economy shows sustained improvement. The Fed will keep overnight rates near zero and continue to purchase treasury bonds and mortgage-backed securities. Their objective is to utilize monetary policy to support the economy until the recovery is complete.
Recent Fed projections are for both economic growth and inflation to be sharply higher this year. The Economy as measured by GDP, is expected to grow by 6.5%, the largest increase since 1983, with some economists forecasting growth to be as high as 8%. The covid-19 vaccination campaigns are making good progress which will continue to allow greater re-openings across the country, while the trillions of dollars of fiscal stimulus will help propel a continued expansion.
The central bank reiterated their commitment to full employment and an inflation rate at 2%. The unemployment rate is near 6% and will likely need to fall to 4.5% to meet the Fed’s objective. There are still 10 million fewer jobs in the U.S. economy than in the months before the pandemic. The real unemployment rate, counting those who have stopped looking for jobs, may be as high as 10% suggests Fed Chair Powell.
Recent core inflation figures are still showing increases below 2%. With an economy continuing to open up and expand we expect that 2% inflation target to be easily achieved in the next two quarters. But the Fed will not likely raise short term rates this year. Their objective is to see a sustained level of price increases before taking action. Inflation temporarily above 2% will not elicit a response from the Fed.
Historically the Fed has been slow to tackle inflation and some economists worry of an impending surge in consumer spending in the months ahead. On average, both households and businesses are in much better shape coming out of this recession. A combination of rising home prices, the rapid rebound in the stock market, and massive fiscal stimulus provided by the government has provided a net cash cushion that we expect will fuel more purchasing activity. At this time the risk of runaway inflation is low. Outside of a possible short-term price increase this year, inflation will likely be kept in check both by future Fed tightening and demographics that don’t support long term price increases.
Current stock market valuations are on the higher side of historical measurements. But there is good reason to stay invested. As the economy grows, so will earnings which can bring valuation levels down to a more reasonable level. The forward P/E for the market now above 20, can come back to a more reasonable range in the high teens as earnings increase. This will require a more modest price increase in the overall market. The double-digit increases achieved in each of the past two years may be reduced to mid-single digit increases in the next few years until overall earnings can catch up. Stocks that have been out of favor will have a greater chance of outperforming. We will lean more towards value investing along with stocks that have solid dividends, over momentum and high P/E growth stocks. For our bond portfolios, with interest rates on the rise we have reduced our durations and expect to maintain shorter terms of maturity this year.