A short review of the first quarter

Financial markets rang in the new year with some healthy portions of both uncertainty and optimism. While we are still in the grasp of a global pandemic, the new year brought new leadership in D.C. and fresh stimulus measures, both here and abroad.

US Vaccinations are ahead of schedule

The process of vaccinating the U.S. population is happening ahead of schedule here and in the UK, while progress has been slower than anticipated in Europe, South America, and parts of Asia amidst new variants and new spikes in case counts. Global progress on beating back COVID will remain the #1 narrative driving financial market performance in the months ahead.

Investments in stocks were given a big boost in Q1 by two big stimulus measures that could amount to $4 trillion. There has never been a time in history where so much financial stimulus has been coordinated around the world. Global central banks are keeping financial easing measures in place, and pledging to keep them there while economies rebound, even through an expected bout of inflation in the post-pandemic recovery.

There are compelling reasons to expect the global economy to well throughout 2021, and so far the narrative has prevailed, as global stock markets started the year on a positive note. The United States, the Eurozone, the UK, Japan, and Asia all saw stocks rise during the first quarter.

Bond Prices Fall as Economy Outlook Improves

Things weren’t as pretty in the bond market, but within some price declines is a pronounced silver lining. On the face of it, U.S. bonds slid as yields rose during Q1. The yield on the 10-year U.S. treasury rose 0.83% during the first quarter – the largest quarterly rise in five years. We are watching this trend carefully as it has impacts for both stock and bond investors.

We view the rise in yields as a good trend, as it reflects optimism for strong economic growth in the coming quarters. Bond yields generally rise during times of strong economic expansion. Given that we are coming off the lowest yields in history, we wouldn’t be surprised if yields climbed higher throughout the year. However, we think the velocity of the move will be much slower. What this means is that current yields across the bond market may represent an opportunity for investors who would like to be less aggressive.

The fact that the stock market hasn’t sold off as yields have risen suggests the stock market is comfortable with rising yields, at least for now. We are on the lookout for inflation, but thus far inflation is well below the Fed’s 2% target, and the Federal Reserve has already indicated they’re fine with letting inflation run over 2% for a while before even considering raising short-term interest rates.

Small Caps lead but mega cap tech still strong

Although the S&P 500 did end the first quarter at a record high, it was small caps and so-called “value stocks” that led the way in the quarter. President Biden announced plans for a $2+ trillion infrastructure bill, and this provided a big boost in sentiment for value sectors like energy, industrials, banks, and materials. Stocks in these sectors usually trade at lower valuations to market averages, and after years of underperforming high-growth sectors like technology and healthcare, value started to close the gap in the first quarter.

The first quarter had some dips in the “mega-cap” growth stocks, but each time there was a dip there were buyers stepping in, and the Nasdaq ended up putting up a 3% gain during the quarter. Additionally, since the beginning of April we have seen the roles reverse a bit and mega cap tech stocks have out performed small caps. The Nasdaq is up 6% in April while the Russell 2000, a small cap index, is up less than 1%. These rotations are just another example of why we believe in having exposure to all of these areas of the market, instead of trying to guess which one will do the best at any given time.

Second Quarter Outlook

The market has started the second quarter on solid footing, with most major indices rising anywhere from 1%-5% depending on where you look. Performance continues to vary across market caps and geographies, with large caps currently doing better than small caps and US stocks doing better than international ones. We expect this varying performance to continue.

While it’s hard to forecast what the market will do, we would remind readers that the stock market has historically fallen 5% or more an average of three times per year and 10% once per year, on average. Thus far, there was a 6% drop in early March. That’s been the largest decline this year, and the only one greater than 5%. This isn’t to suggest a 5-10% market decline is imminent, more so it is just a reminder that should one occur it would fall into the category of “normal.” The stock market has had a good start to the year but a pause in the rally would not be a surprise.