In a reversal of the fear and uncertainty that gripped many in the first quarter of last year, investors appear to be looking to the future with a sense of optimism about a US economy poised to reopen. After the rapid market decline last year, the Fed stepped in quickly, providing liquidity to markets and preventing uncertainty from turning into panic. Fiscal policy was also accommodative, with multiple bills designed to provide support to individuals, companies, and states, including the $1.9 trillion dollar bill signed in early March[i].
After unemployment peaked at roughly 14% last year, it is now just above 6%[ii]. Following a recession in the second quarter of last year, economic activity is picking up, with some expectations for 2021 GDP growth around 5% or more. The COVID-19 pandemic ravaged people’s lives, but vaccine distribution is picking up rapidly, with almost a third of the US population having received at least one dose and 17% fully vaccinated[iii]. While we are still dealing with challenges here and now, the future is looking brighter, and equity markets are pricing that in.
Large cap stocks continued their strong performance into the new year, although some pullbacks were seen along the way as the growth names that did so well in last year’s pandemic leveled off to some degree.
Small cap stocks, which fell more than their larger counterparts at the onset of the pandemic, have experienced a robust recovery as investors rotate into them in anticipation of the reopening economy. Once the dust settled, they outperformed their larger counterparts last year, and that trend has continued into 2021 with small cap stocks performing well above the other major indices shown.
Developed and emerging markets stocks posted solid results but fell short of the US market to start the year. In a reversal of the previous year, returns for US investors in international markets were hurt by a strengthening US dollar as well as slower vaccine distribution in some countries relative to the US.
Value’s outperformance relative to growth has carried on from the fourth quarter into the new year (both in the US and across the pond) behind rapidly increasing vaccine distribution. Many traditional value sectors, such as financials and energy, were directly impacted by the shelter in place orders last year, and investors are rotating into these sectors now that they are looking to a post-vaccinated world. In fact, the rotation has been so pronounced that small cap value was up over 21% for the quarter. Large cap value (+11.3%) was well ahead of the overall large cap index shown above[iv].
Not all markets are rallying, however. In fixed income, US investment grade bonds fell to start the year and municipal bonds remained relatively flat. It is not unusual for bonds to move opposite to stocks; in fact, it is part of why the combination of both contributes to a well-diversified portfolio. After posting high returns in 2020 behind a historic drop in yields, those same yields are now recovering to the highest level they have been in over a year.[v] Lower credit quality bonds were affected by rising yields, but that was offset by improving credit quality. By quarter end high yield bonds ended flat, much like municipals. Local emerging markets bonds had the greatest decline, exacerbated by the strengthening US dollar.
2021 has started off on a positive note for investors, but it has been far from boring. Just as equity markets continued to rally on brighter economic news, bonds retreated for the same reason given the rise in interest rates. These mild declines in fixed income were not large enough to offset the gains in stocks in a well-diversified portfolio. Investors who benefitted from their discipline during the roller coaster ride of 2020 continued to make good progress in the first quarter of 2021.
[i] Pramuk, Jacob. 2021, https://www.cnbc.com/2021/03/11/biden-1point9-trillion-covid-relief-package-thursday-afternoon.html Accessed 6 Apr 2021.
[ii] Rockeman, Olivia. “U.S. Job Growth Surges Past Estimates; Unemployment Dips To 6.2%”. Bloombergquint, 2021, https://www.bloombergquint.com/global-economics/u-s-feb-payrolls-increase-379-000-est-200-000 Accessed 6 Apr 2021.
[iii] “US COVID-19 vaccine progress”, https://usafacts.org/visualizations/covid-vaccine-tracker-states/?utm_source=google&utm_medium=cpc&utm_campaign=ND-COVID&gclid=CjwKCAjwu5CDBhB9EiwA0w6sLXNplkorJ_GO0G7rJDYBnB_2w0uo5UlbEUbvsPM5wtRG2daI17-MKRoCXBMQAvD_BwE Accessed Apr 6 2021.
[iv] Source: Morningstar Direct. Data as of 3/31/2021.
[v] Bala, Sumathi. 2021, https://www.cnbc.com/2021/03/23/us-10-year-treasury-yields-could-move-higher-to-2percent-fidelity.html Accessed 6 Apr 2021.
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Dow Jones Industrial Average Index: measures the performance of 30 large, publicly-owned companies trading on the New York Stock Exchange (NYSE) and the NASDAQ.
Russell 3000 Index (U.S. Stock Market): measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market. These securities are traded on the NYSE, NYSE MKT, and NASDAQ.
S&P 500 Index (Large Cap U.S. Stocks): measures the performance of large capitalization U.S. Stocks. It is a market-value-weighted index of 500 stocks that are traded on the NYSE, NYSE MKT, and NASDAQ. The weightings make each company’s influence on the Index performance directly proportional to that company’s market value.
Russell 2000 Index (Small Cap U.S. Stocks): An unmanaged index that measures the performance of the small-cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index, representing approximately 10% of the total market capitalization of that index and includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. Russell Investment Group owns the Russell Index data, including all applicable trademarks and copyrights.
Russell 2000 Value Index (Small cap Value): An unmanaged index that measures the performance of small-cap value segment of the U.S. equity universe. It includes those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values.
Russell 1000 Value Index (Large Cap Value): An unmanaged index that measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the larger Russell 3000 Index and represents the 1000 top companies by market capitalization in the United States.
MSCI EAFE Index (International Developed Stocks): The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada. The MSCI EAFE Index consists of the following 22 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
MSCI Emerging Markets Index (Emerging Markets Stocks): is a Morgan Stanley Capital International Index that is designed to measure the performance of equity markets in 23 emerging countries around the world.
Bloomberg Barclays US Aggregate Bond Index (U.S. Bond Market or Investment Grade U.S. Bonds): includes U.S. government, corporate, and mortgage-backed securities with maturities of at least one year.
Bloomberg Barclays Muni Bond Index 1-10 Yr Blend (1-12) (Int-Term Municipal Bonds or US Municipal Bonds): A market value-weighted index which covers the short and intermediate components of the Barclays Capital Municipal Bond Index. The 1-10 Year Municipal Blend index tracks tax-exempt municipal General Obligation, Revenue, Insured, and Prerefunded bonds with a minimum $5 million par amount outstanding, issued as part of a transaction of at least $50 million, and with a remaining maturity from 1 up to (but not including) 12 years.
ICE BofA Merrill Lynch U.S. High Yield, BB-B Rated, Constrained Index (High Yield U.S. Bonds): Tracks the performance of US dollar-denominated below-investment-grade (BBB rated) corporate debt publicly issued in the US domestic market. Qualifying bonds are capitalization-weighted provided the total allocation to an individual issuer does not exceed 2%. Issuers that exceed the limit are reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis.
JPM GBI EM GD USD Unhedged Index (Emerging Markets Bonds): The JP Morgan EMBI Global Diversified is a uniquely weighted index that tracks total returns for U.S. dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities. The index limits the weights of countries with larger debt stocks by only including a specified portion of these countries’ eligible current face amounts of debt outstanding.
JPM EMBI GD Index: J.P. Morgan Emerging Markets Bond Global Diversified Index (EMBI Global Diversified) tracks the returns for U.S. dollar-denominated debt instruments issued by emerging market sovereign and quasi- sovereign entities: Brady bonds, loans, Eurobonds. The index limits the exposure of some of the larger countries.