First Quarter 2021: Market Review & Outlook
Investors poured into stocks as the economic glass appears to be half-full
US stocks rallied for the fourth consecutive quarter as the S&P 500 gained over 6% on investor optimism about vaccine distributions and additional stimulus. Value investors were amply rewarded as the pro-cyclical rotation continued and rising treasury yields induced profit-taking in growth stocks. Also helping the markets was a 4% increase in S&P 500 earnings coupled with positive commentary from management regarding tailwinds to growth in the near future.
The market started the year off strong rising 3% before a retail investor-induced short-squeeze dragged stocks to a net 1% loss for January. Energy and Financial stocks exploded in February leading a cyclical rally that produced a nearly 3% gain in the markets. The gradual lifting of COVID restrictions and eventual approval of increased stimulus gave investors even more economic optimism that helped push stocks to a sizable 4% gain in March.
Fed not bothered by rising treasury yields…for now
Much of the cyclical rotation for the quarter could be attributed to the sharp rise in treasury yields. The 10-year rose from 0.92% at the end of 2020 to a peak of 1.78% during the quarter (The long-bond increased from 1.65% to upwards of 2.52%). As yields heated up, the conversation quickly turned to how long the Fed could stay pat on keeping rates at near-zero levels.
Fears of the seemingly inevitable raising of interest rates by the Fed hampered growth stocks for the quarter even as Fed Chair Powell publicly and repeatedly held to a dovish stance. He reiterated that the Fed is committed to remain accommodative until sustainable growth is seen in both the labor market and inflation levels. Other Fed speakers echoed this sentiment stating that most inflationary pressures seen so far appear to be transitory.
Retail investors brought the drama
The drama surrounding meme stocks (out of favor companies pushed fervently on message boards such as Reddit) was one of the most interesting stories of the first quarter. Aside from a late January spike in volatility, the artificial boost in certain meme stocks had no significant benefit on the rest of the market. However, the implication from this episode is that investors are finding more avenues to embrace risk in this market. Much of this retail frenzy was executed using the higher leveraged, less well-understood method of options trading on free online brokerage platforms designed to look more and more like video games. And plenty of other avenues have emerged for those looking for other non-traditional ways of taking on risk in this market including celebrity-funded SPACs, art-themed non-fungible tokens and cryptocurrency based off a dog meme.
Vaccine distribution gives investor optimism a shot in the arm
Another, more impactful story in the first quarter was the acceleration of vaccine distribution across the U.S. President Biden’s goal of 100 million vaccinations was easily eclipsed by 50 million doses at the end of March. Declining trends in both new cases and hospitalizations caused many state and local leaders to ease restrictions on mask mandates and crowd gatherings.
Investors cheered these developments by piling into retail and industrial stocks they felt would benefit from more foot traffic and project backlogs. Economic data released in the quarter further supported investor enthusiasm as indicators for air travel, vacations, consumer spending, and the labor market all showed notable improvements. Management added in extra optimism during corporate earnings as the vast majority exceeded street estimates and raised guidance during their quarterly announcements.
Market resilience will continue to be tested by rising yields
The S&P 500’s 12-month 56% return adequately reflects the incredible resilience of the market in the face of a pandemic that had devastating effects on the global economy over the past year. As shocking as the first quarter of 2020 seemed, it appears to have been nothing more than a transitory negative blip in a long-term bull market that refuses to slow down.
Much ado has been made of the bull market dying on the long overdue rotation from growth stocks into value. So far this year, that rotation has had the opposite effect – causing a rally based on fundamental data as opposed to exuberant speculation. However, the fundamental base for the optimism, an improving economy, is starting to cause uncertainty around the continuation of accommodative monetary policy. As that uncertainty rises, the market is likely to experience a much more volatile path to record highs.