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April 2021 Investment Commentary
Financial markets in 2021’s first quarter reflected improving conditions on the ground and significant brightening in fundamental outlooks. This benefitted equities generally, completing a powerful 12 months as shown in the table. Bondholders meanwhile saw sharply negative returns, driven by rising interest rates. The bellwether 10-year Treasury yield moved up from 92 to 175 basis points, as firmer economic views ushered in new inflation concerns. This brought down Treasury prices and weakened other bond groups priced off of Treasuries, including investment-grade corporates. Our defensive bond positioning proved helpful in this environment. The “reflation trade” also supported a shift toward economically sensitive stocks while large technology stocks were hit by profit-taking. Client portfolios generally gained, and were aided by added exposure to dividend-paying (and generally more economically driven) stocks at the beginning of the year.
|First Quarter||Last 12 Months||Five Years (ann.)|
|Developed International Stocks||3.5||44.6||8.9|
After a very strong two years, bond investors became reacquainted with downside risk in the first quarter’s rising rate environment. The Bloomberg Barclays U.S. Aggregate index lost 3.4% in the period, a worse return than the worst year over the last 45 years, a 2.9% drop in 1994. U.S. Treasury investors experienced the amplified risk of high duration (essentially a weighted measure of when principal and interest is received) tied to low initial yields. In round numbers, a 10-year Treasury yielding 1% would lose 9% of its value if rates were to rise 100 basis points (1%), and we traveled about four-fifths of that path in the quarter. Municipal bonds showed relatively modest losses (closer to 1%) as credit views improved. The global index in the table also felt a dollar strength headwind in the quarter (the euro and yen dropping 4.0% and 6.7%), having enjoyed the opposite last year.
Inflation wariness indeed gained momentum over the quarter, mostly reflecting an anticipated surge in spending this year as the economy finally breaks the bounds of COVID-19 and re-opens in full. More immediately, President Joe Biden’s $1.9 trillion rescue package, signed into law on March 12th, directly and aggressively supports consumers, particularly lower earners more likely to spend rather than save what they receive. Inflation concerns also have risen on potential supply chain challenges and balky labor mobilization inherent in this re-opening, marked by its broad scale and high logistical uncertainty. At the same time, Federal Reserve Chair Jerome Powell has expressed inflation attitudes more relaxed than Fed-watchers typically expect, in fact welcoming the possibility of above-target (2%) inflation on a temporary basis, in exchange for more robust job restoration.
The quarter also was characterized by the type of “risk-on” trading behavior one often sees following a period of strong returns. Bitcoin and other cryptocurrencies posted gains of 100% or more, and we saw the emergence of the “NFT”, or non-fungible token, which attaches to and prices a single digital image, one of which was auctioned off by Christie’s for $69 million. Publicly traded shell companies or “SPACs” (special purpose acquisition companies), essentially a blank check entity created to buy a private company, proliferated, many lacking clear objectives. Individual investors banded together to drive up prices in marginal companies such as Gamestop, triggering price surges and short squeezes, and nightmares for hedge fund managers. And a highly leveraged family office hedge fund called Archegos ended the quarter by defaulting on two margin loans, leading to its liquidation.
The risk takers, and investors in general, are taking confidence from recent economic trends. After a 3.5% GDP contraction in 2020, most economists, Powell included, are looking for a recovery and growth in excess of 6% in 2021, with upper-end views around 8%. The latter figure would represent the strongest expansion since 1951. With two-thirds of GDP outcomes tied to consumer outlays, this level of growth assumes not only spending of COVID relief dollars but also a strong and steady improvement in labor markets. After peaking at 15% last April, the unemployment rate now stands at 6.0%, and expectations are for continued improvement as we continue to bring back workers, from the 9.5 million still idled (comparing February 2021 to February 2020). We’ve seen healthy gains recently, including a well above forecast 916,000 added in March.
Successful vaccine deployment remains the key factor in any recovery scenario. And progress has been impressive, with daily dosing rates moving up from 1 million a day around 10 weeks ago to just under 3 million today. From zero in mid-December, roughly 30% of the U.S. population has now received at least one shot, placing us among the leaders, trailing only a few nations such as Israel (60%), the U.K. (45%) and Chile (35%). Including natural immunity from having had COVID, our population may be 40% immunized, a bit more than halfway toward the 75% level that should sustainably keep COVID in check. Fortunately, 90% of all U.S. adults will be eligible for vaccines by April 19th, and there should be enough supply to meet this demand by next month. Barring major complications, the prospects for reopening and economic recovery remain wholly intact.
President Biden’s early policy approach has fortified these views, while also shedding light on his legislative strategy in today’s political weather. In an era when multi-trillion-dollar spending packages have become fathomable, he is quickly aiming high, and potentially transforming the public sector’s role in our economy. While running as a moderate with a history of cross-aisle conciliation, the March relief bill involved little courtship of Republicans. Thanks to the Georgia run-off wins, Democratic unanimity, and the 51/50 majority under the “budget reconciliation” maneuver, Senate passage was enabled. As this reconciliation threshold can be applied to spending bills, it seems inevitable that we’ll see this again, as Biden pivots to his $2.3 trillion infrastructure package, the American Jobs Plan, announced on March 31st. The hope is to gain passage by mid-year, and then move on another major bill, geared to helping families, including health care and child-care reforms.
After 12 months in which $6 trillion to fight COVID was largely borrowed, the infrastructure bill is geared to longer term investment in our productivity, and it will require tax revenue offsets. The spending is expected to be spread over eight years, or about $250 billion per year. It is focused on transportation, including upgraded highways and mass transit, and electric vehicle charging stations, along with expanded broadband access to better include rural America, and modernized public housing. Funding would come from higher corporate taxes, spread over 15 years, in $125-150 billion increments. This would come from moving the tax rate from 21% to 28%, retracing half of the cut enacted in Donald Trump’s 2017 bill, and from increasing taxation on overseas profits. Personal taxation is left alone in the infrastructure package, but will be in play as part of the American Family Plan proposal to be detailed later this Spring.
On the strength of this level of current and potential government spending, the continuing accommodation of Powell’s Fed, and a consumer re-emergence from COVID lockdown, upper single digit GDP growth forecasts for 2021 are not surprising. The shape of recovery beyond this year, however, will likely be subject to laws of economic gravity. Fiscal sobriety will return at some point. At its March policy meeting, Powell and his Open Market Committee followed up a projected 6.5% GDP advance with an easing back to 3.3% in 2022 and 2.2% in 2023, with growth settling at around 2.3% thereafter. This would be about the pace that characterized the decade-plus expansion prior to COVID. Arguably, this could be improved if Biden’s initiatives are enacted and effective, and we see more permanently enhanced productivity, leading to higher output and personal incomes.
Likewise, corporate earnings growth looks to be on a healthy track, with sharp gains in 2021 and continued improvement in 2022. This has supported stock prices. But there are unknowns as we negotiate the re-opening and define a new post-pandemic landscape. Going forward, depending on political ebbs and flows, more attention also will be paid to the affects of potential tax increases on earnings under the new Biden proposal, as well as the revenue and earnings benefits tied to infrastructure spending and spending by a better employed workforce. The hit may indeed happen sooner than the benefit, but both can and will be discounted in present day pricing.
On this backdrop, portfolios continue to hold a full equity weighting, maintaining a commitment to high conviction active managers who have shown an ability to be opportunistic during times of unusual change. We pair this with enhanced defense in the rest of the allocation, including a conservative bond mix, limited hedge fund exposure, a zero commodity weight and modestly elevated cash. We are suggesting one change, trimming a position in a small value manager on strength, including a better than 100% gain over the last 12 months.
Through regular rebalancing, we’ll be adding exposure to U.S. Treasuries and investment grade corporates, which have become more attractive on the significant weakness. Moreover, any inflation pressure tied to the re-opening seems likely to ease as supply chain logistics are smoothed out, and workers more freely return as their COVID relief dollars taper off.
Well wishes to all and hopefully you are enjoying warmer weather. Thank you as always for your continued confidence. Please reach out to us as necessary with any questions and concerns.
David S. Beckwith, CFA
Managing Director & Chief Investment Officer
Jason D. Edinger, CFA
This letter may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.