The first quarter of 2021 was a turning point in both the pandemic in the United States and the economic damage it has caused. Stocks have not lost any of their luster from the end of last year. Despite a few episodes of heightened volatility, the equity markets marched steadily higher in the first quarter of 2021, with all the major indexes posting solid returns from high single to double digits. The market rally this quarter was driven by the progress of the vaccine rollout, accommodative monetary policy and fiscal stimulus.
The big story for the first quarter was the continuation of a leadership rotation that began in November of 2020. Prior to that point the market was dominated by technology companies whose business was immune to COVID pandemic, and in some instances, benefited from it. However late in 2020, in anticipation of the reopening of the economy, cyclical companies and value stocks started to move ahead, and this trend manifested itself profoundly through the quarter, with the financials and industrial sectors of our economy leading the way. Similarly, mid and small capitalization companies outperformed their large counterparts.
Equity markets around the globe also delivered strong results. Looking at broad market indices, developed markets outside the U.S. posted positive returns for the quarter, underperforming U.S. equities but outperforming emerging markets.
After a strong 2020, the bond market stumbled out of the gate with yields rising sharply in the beginning of the year. The 10-year U.S. Treasury began the year with a yield of 0.93%. It closed the first quarter at 1.7%. This caused most bond indexes to decline, with the core Barclays U.S. Aggregate Index falling 3.4%. The top performing bond segment was the Barclays High Yield U.S. Corporate Index.
The U.S. economy continued to demonstrate an impressive recovery. Massive liquidity provided by the Federal Reserve over the last year, coupled with the success of Operation Warp Speed which led to the amazingly fast development of multiple, highly effective vaccines put the U.S. in an enviable position for 2021. However, economic signals have been mixed in recent months. While business confidence has been strong since last fall, consumers have been slower to get comfortable with the impending end of the pandemic. It is still the case that the benefits of the recovery have not been reaching all Americans as several million workers are suffering the effects of long-term unemployment. On a positive note, the third wave of relief checks in March and the continued progress on vaccine distribution helped to boost U.S. consumers’ confidence to the highest level since March of 2020, reflecting increased optimism and higher expectations. Due to less travel and other restricted discretionary spending, consumer net worth reached an all-time high in March, and when this mountain of excess savings is unleashed in the form of spending, it may result in huge GDP and job gains for the remainder of 2021.
As we enter the second quarter, more and more U.S. economic leading indicators are pointing toward rapidly strengthening economic growth. They also suggest rising inflationary pressure as rapid demand, low inventories, and continuing supply chain constraints may lead to rising prices. However, the Federal Reserve views this possibility as temporary, since it presented itself early in the economic cycles and it is determined to keep its monetary policy accommodative in order not to risk short-circuiting the economy even if inflation rises, focusing solely on its employment mandate.
March 23, 2021 marked the one-year anniversary of the 2020 market bottom. Therefore, the end of the first quarter wrapped the first year of a new bull market that began on March 24, 2020. After just one year and despite a few pullbacks of consequence, the 80+ percent rise in the S&P 500 Index represents the best first year of a bull market in over six decades. History teaches us that since the middle of the last century, every second year of a bull market had positive returns with an average in low to middle double digits, despite some 5 to 10 percent corrections occurring during them. While we do not expect the year of 2021 to be an exception to these historic precedents, the proposed increase in the corporate tax rate from 21% to 28% could make it a bumpy road. It is hard to assess to what extent this tax hike is already priced into the market and how the policy, that seeks to boost growth at a time when economic activity already has good momentum, will finally play out. Therefore, it would be realistic to view this issue more as a volatility factor than a major threat to the young bull market.
The 2020 recession was not a normal one, and neither was the last year’s bear market. Both will most likely remain the shortest on record for years. But by the same token, can the recovery which we are currently witnessing, and which is fueled by enormous stimulus and a monetary policy that is no longer attempting to moderate the business cycle, also be short-lived? No one can know for sure, and we hear respected economists arguing both sides of the debate. We do know that while the future is always uncertain and the market favorites are always shifting, the path to financial security remains the same: diversify your portfolio, have a plan, and follow it even when times are tough.
Dumont & Blake Investment Advisors, LLC
March 31, 2021