What a difference a year makes. The first quarter of 2021 included the one-year anniversary from the March 2020 equity market’s pandemic lows. In the Q1 2021, equity markets encountered some volatility but still managed to close toward the highs. With a potential for herd immunity following mass vaccinations, investors finished the quarter with hopes that the end of the pandemic could be seen by the Q3 of this year. Many optimists are hoping that the US economy will continue to accelerate when this happens. The Dow Jones Industrial Average, S&P 500 and Nasdaq indexes finished the quarter positive, marking the fourth consecutive quarter of doing so.
At the beginning of the quarter, the US Treasury and IRS began delivering a second round of Economic Impact Payments outlined in the prior quarter's $900 billion COVID Relief Bill. This stimulus provided for the extension of many critical Paycheck Protection Program (PPP) and unemployment benefits as well as for additional direct payments of $600 for qualifying individuals.
On March 11, newly elected President Biden signed into law his $1.9 trillion American Rescue Plan which extended unemployment benefit with a $300 weekly supplement until Labor Day 2021. Aside from providing and additional $1,400 of direct payments, the plan expanded on many tax relief provisions and allocated $350 billion to help state and local governments bridge budget shortfalls.
At the end of the quarter, President Biden introduced an outline of his infrastructure spending plan, which quoted a $2.3 trillion dollar price tag. This proposed plan is expected to focus on a broad range of infrastructural activities such as: developing roads, airports, safe water supplies and greener technology. This plan could rise to an even higher dollar amount and it comes with a proposal to raise the corporate tax rate from 21% to 28%.
At the March Federal Reserve monetary policy meeting, the Fed upgraded its economic growth outlook for 2021 to 6.5%, up significantly from its last projection of 4.2%. They also projected unemployment rates to dip to 4.5% and inflation to rise to 2.4% by the end of 2021. Despite the more positive outlook, the Fed did not change its near-zero interest rates decision through the end of 2023.
In a joint appearance in front of the US House Committee on Financial Services on March 23rd, Treasury Secretary Janet Yellen stated, "We are meeting at a hopeful moment for the economy — but still a daunting one. While we are seeing signs of recovery, we should be clear-eyed about the hole we're digging out of." Fed Chair Jerome Powell added that while the housing market has fully recovered from the downturn, that “Business investment and manufacturing production have picked up but spending on services remains low.” (Source: nbcnews.com 3/23/2021)
During the quarter, many consumers' options were still limited by the need to still social distance. Many businesses in the travel, hospitality and retail sectors were still heavily restricted by many state-imposed operation rules and consumer sentiment had only started to shift toward the prospects of the economy returning to normalcy. Normalization of behavior following mass vaccination could mean a major uptick of consumer services, which would drive an overall Gross Domestic Product (GDP) recovery. The job market is also projected to recover in tandem with consumer services, as the service sector accounts for most of the lost jobs from the pandemic. Another massive stimulus injection started reaching eligible Americans as a result of the March 2021 government stimulus bill. Households and firms alike benefited thanks to record stimulus in 2020, however, the U.S. federal deficit reached its highest level outside of World War II. Although this becomes a bet that the U.S. economy will recover from the pandemic, the totality of new debt still is at a very high amount.
US AND THE GLOBAL ECONOMY
The consensus remains that economic recovery is still largely based on the containment of the virus and the progression of vaccination distribution. The quarter closed with further distribution of the vaccine combined with consumer activity, continued re-openings and unemployment reduction being very hopeful.
There is no doubt that the deluge of government and central bank stimulus has contributed substantially to the strength of the consumer. Unlike previous recessions, consumer debt actually declined (as opposed to rising) as a result of the quick action taken by Congress and the Fed. For the quarter, consumer debt (which includes credit card and lease payments) continued this trend at a moderate pace. Consumer debt levels ended the quarter 12% lower than March of 2020 which was the all-time high for this measure.
The unemployment picture for the U.S. continued to improve at a slower rate than prior quarters with the March reading coming in at 6%. The number of nonfarm job openings accelerated to over 7.3 million in February above pre-pandemic levels. Many would have expected a sharper decline in unemployment given the robust number of job openings and there are a few theories that explain this disconnect. One theory attributes the extension of additional unemployment benefits as a disincentive to many lower paying job seekers. Another explanation is that employers are unable to find qualified candidates with the skill sets needed for the expansive list of higher tech jobs. Then again, there could just be a delay in job seekers finding the right employment opportunity. Regardless, the trend of job openings remains very supportive to the health of the labor market in the coming quarters.
Both manufacturing and service based economic growth continued to advance globally for the first three months of the year showing readings well above the expansionary threshold of 50. Manufacturing activity as referenced by the Manufacturing Purchasing Managers Index (PMI), had a 55 reading in March, a level not seen in over a decade. Although growth in the services sector improved, it still trailed the progress in manufacturing activity as the future for many service-based businesses hinges on the pace of economies reopening this year.
The volatility in interest rates was a focal point for both equity and fixed income markets for the quarter. The surplus of stimulus combined with improving labor growth and economic activity had markets discounting the potential for greater inflation in the months ahead. The Fed asserting that it had no intention to until 2023 exacerbated inflationary fears. As a result, long-term rates started to noticeably rise in February with the 10-year Treasury reaching a pre-COVID level of 1.75% by March. The 10- year yield started the year at just under 1.00%.
Equity markets experienced some volatility because of rate pressure early in the quarter but were able to shake off fears that the economic recovery would be derailed by an inflationary shock. Fixed income markets on the other hand were not as insulated against rising yields and reacted more negatively to this prospect as high levels of inflation are more difficult to overcome for fixed investments.
The rise in yields for the quarter needs to be put into perspective given the extremely low levels that were reached in the wake of the pandemic. The monetary action that the Fed delivered last year was meant to counter the severe economic turmoil created by COVID. To provide ample liquidity for markets to help with the recovery, it needed rates to decline to accomplish this. Now that the economic recovery is gaining traction to pre-pandemic levels, it is only logical that rates would graduate back to similar levels. The fear of rapid inflation is certainly a concern for capital markets and this is a metric that we will need to watch closely in the quarters ahead. However, many economists have attributed the initial rise of inflation due to supply chain bottle necks and economies recalibrating to the reopening.
Global equities provided modest returns for the quarter with US equities continuing their post-election move. Valuations across the S&P 500 continued to remain at multi-decade highs with the forward price-to-earnings ratio closing at 21.9 for the quarter. Price levels for most broad market equity indexes continue to be scrutinized by many market skeptics when making historical comparisons. However, it is important to realize the impact that fiscal and monetary stimulus have had in supporting price levels as the recovery in corporate earnings continues. With corporations starting to report their Q1 earnings, it is expected that they will grow over 20% from the prior year based on current analysts’ consensus. This puts corporate earnings on track to potentially grow 26% for 2021 a stark improvement from the nearly 14% decline experienced in 2020. The large move in equity prices and valuation figures during last year seems to have diminished for the time being. At this point, it seems that the equity markets are patiently awaiting for earnings to catch-up to these higher valuation levels. A disappointment to the recovery in earnings in the quarters ahead does pose a risk to stock market levels.
Both small caps and economically sensitive sectors continued to outpace the “stay at home” investment themes that were popularized during the peak of the pandemic. Stay at home investment themes being sectors/business models that were less interrupted by the effects of quarantine and social distancing. This shift in leadership makes sense given the arrival of COVID immunizations and the focus on reopening parts of the economy that were severely impaired by COVID restrictions. Both developed international and emerging markets reverted to their prior trend of underperforming US markets as many of these economies were faced with an uptick in COVID cases, an increase in restrictions and less access to immunizations.
FIXED INCOME MARKETS
Bond yields across the globe adjusted upward for the quarter creating nominal losses for the aggregate bond market during the quarter. (Remember that bond prices move inversely with prevailing interest rates. When rates rise, bond prices tend to retreat.) Longer-term US treasury bonds were the most affected by the upward adjustment in rates from the 2020 August lows. While the more credit sensitive sectors of the high yield and mortgage-backed sectors outperformed.
The amount of monetary and fiscal support along with the gradual reopening of the US economy have many fearful that inflation will continue to pressure bond prices as a result of yields adjusting higher. Although the Fed has indicated that it is indeed welcoming inflation, it is important to consider that much of the inflationary pressure that ensued during the quarter may be more transitory in nature and the recent back-up in yields is a healthy part of the economic recovery. Bond yields could very well continue to rise as the strength of the economy improves. However, if the recovery falters or is much slower than expected higher quality bonds should provide a meaningful offset to the unknown risks of the equity markets. Also, it is important to note that both the US Fed and Treasury are mindful of yields rising too fast as this could derail their plans to achieve full employment as well as maintain reasonable borrowing costs to fund deficit spending.
NOISE AND DISTRACTIONS
As if investors did not have enough to think about, the first quarter of 2021 brought major drama when Gamestop, a video game retailer that Wall Street bet heavily against, saw a rise of over 2,000% in its stock price. This surge was initially and primarily triggered through the social news platform, Reddit. The drama that ensued prompted Congress to hold hearings focused on the state of the stock market and questionable practices.
Media magnification is a powerful force. Sensational headlines can leave investors overwhelmed, stressed, and confused. If you have carefully created a strategy with realistic financial goals, veering off course in the hopes of short-term gains could potentially compromise the financial fortitude of your long-term goals.
The upcoming release of Q1 earnings will be critical to evaluate the progress of the recovery in corporate revenue and profitability. Investors could also see market moving news come from the continued successful rollout of the vaccine and reopening of the economy. Current reports show that nearly one-third of US adults have received at least one dose of the vaccine and heard immunity may be reached before year end. This gives us confidence that the vaccination efforts will provide a sustainable path to both economic and market recovery in the quarters ahead.
As mentioned earlier, the Biden administration is proposing an additional plan that could further bolster the economic recovery by assisting in renovating infrastructure and taking measures to fight climate change. On March 21, White House Press Secretary Jen Psaki said the administration is considering releasing this plan in two phases, one that boosts manufacturing and transportation and environmental sectors, while the other focuses on economic inequalities. (Source: cnbc.com 3/22/2021)
Altogether, there is great confidence that the US economy will recover from the pandemic and that the combined efforts of the Federal Reserve and fiscal spending will be supportive to financial markets. But there are always risks that market growth could become tepid or that inflation causes conditions to become more volatile. Regardless of what equity markets are doing, our goal is to make sure that your investing plan is centered on your personal goals and time horizon. Even when investing for the long-term, there is no guarantee that market volatility will decrease, stabilize, or increase over any time frame. However, with the proper planning, we can ensure that your portfolio’s risk exposure is inline with your ability and willingness to assume risk.
FINANCIAL PLANNING TIPS TO CONSIDER
1. Did you know that a HEALTH SAVINGS ACCOUNT (HSA) is one of the most powerful tax-advantaged savings tools?
Many people overlook its benefits but we can talk with you and introduce you to the many ways you can benefit from this strategy. It's a great tax deductible tool to use for eligible medical expenses and can be used as a retirement investment. You can also make a one-time rollover from an IRA to an HSA, transforming the tax-deferred retirement savings into an account you can tap into tax-free withdrawals for medical costs.
At Prestige, we can help you navigate the complexities of this type of rollover so you don't have to.
2. Mega Backdoor Roth IRAs are complicated retirement savings strategies. But for the right person, they could offer a big tax advantage. If you're looking for a way to maximize your withdrawals in retirement, this may be the right strategy for you. It allows high earners, or perhaps someone who experiences a windfall of cash, to contribute up to $37,500 in a Roth IRA or Roth 401(k) account - on top of their regular contributions. This option is not available to everybody, as some 401(k) plan providers do not allow it. For IRAs you can get up to the maximum annual IRA contribution, currently $6,000 or $7,000 if over 50 into a Roth IRA. Roth accounts grow tax-free and withdrawals after 59 1/2 are also tax-free.
If you’re considering this option, you’ll want to work with one of our wealth advisors to determine first whether it may be beneficial to you, and whether or not you may be hit with an unexpected tax bill as a result.
DISCUSS YOUR CONCERNS WITH US
Whether you're seeking tax strategies, estate planning or a financial plan, our advice is not one-size-fits-all. We're ready to provide you with the financial solutions you need for a better retirement. We will always consider your feelings about risk and the markets and review your unique financial situation when making any recommendations.
At Prestige, we design custom portfolios with the goal to both protect and grow your wealth. Our wealth advisors are ready to help you with an obligation free complimentary review of your portfolio. If it's good, we'll tell you. If it's not, we'll provide feedback on things that can help.