Windsor Perspectives: Q2 2021
In this edition of Windsor Perspectives, we discuss the continuation of last year’s strong stock market performance into early 2021. We also explore potential opportunities for investors, as well as risks they may face, should that recovery continue against the backdrop of a brisk vaccine rollout in the US, and with a broader reopening of the economy on the horizon.
Cumulative COVID-19 Vaccination Doses Administered per 100 People
Cyclical Stocks, Small Caps, and International Equities Providing Leadership
The US stock market performed well in the first three months of the year. The Dow, the S&P 500, and the Russell 2000 all hit record levels in March. This strong performance across different stock market indices reflects expectation of continued economic growth. In addition, cash on the sidelines continues to bolster demand for equities as Bank of America reported that in mid-March, global equities attracted a record $68.3 billion.
We previously anticipated opportunities for investors in small-cap companies, value-oriented cyclical industries, and international equities. These expectations have been borne out in early 2021. In fact, sectors such as energy, travel, and financials have begun to pull ahead of growth stocks in heavyweight tech companies. Travel-related stocks and housing continued their strong performance as well. These cyclical sectors should benefit further from the reopening of the economy as the coronavirus pandemic continues to subside.
Existing Home Sales (millions)
US TSA Total Traveler Throughput (14-Day Avg) vs OpenTable US Seated Diners Y/Y% Change (14-Day Avg)
Stocks of small cap and international equities have also been doing well. For the first quarter, the Russell 2000 (which reflects the performance of these smaller companies) was up over 10%. In the past, we’ve seen this type of performance at the beginning of a longer-term economic upturn. If more of these small-cap companies turn profitable, this would be another sign that economic recovery is settling in. Meanwhile, international shares in developed and emerging markets have continued to rise, especially in commodity-exporting markets.
MSCI ACWI Index (Y/Y Pct Chg) vs. Global Manufacturing PMA (SA)
Bond Yields Going Up amid Improving Economy, Fiscal Stimulus, and Low Interest Rates
The first quarter of 2021 saw a continuing rise in bond yields, too. The 10-year Treasury bond yield—the benchmark measurement— rose to end the quarter at 1.74%. This increase was triggered by the latest fiscal stimulus package as well as expectations of an ongoing economic recovery. In addition, concerns that the Federal Reserve may be leaving its low-rate strategy in place too long, allowing the economy to “overheat”, could spark inflation. Will higher interest rates eventually drag down the stock market? As Bank of America notes, however, similar surges in bond yields have happened before without driving stocks lower. We continue to monitor the relationship between interest rate changes, the economy and the stock market.
US 10 Year Treasury Bond Yield (%)
There’s been some speculation in the media that the $1.9 trillion fiscal stimulus package—signed into law on March 11th—could be funded by an increase in the corporate tax rate, from 21% to somewhere between 25% and 26%. Goldman Sachs recently estimated that a 25% corporate tax rate would reduce 2022 S&P earnings per share by 3%, but even so, earnings would still grow by 15% overall. It’s also worth noting that in a recent Bank of America survey, global fund managers said they expected higher taxes to pose less of a risk to stocks than the possibility of inflation, bond market volatility, a slow vaccine rollout, or a so-called “Wall Street bubble” (pockets of speculative activity and intense trading).
Meanwhile, we don’t expect a change anytime soon to the Federal Reserve’s low short-term interest rate policy. The Fed is emphasizing the continuation of its 2020 strategy, which involves average inflation targeting and a push for a strong labor market recovery to tackle pandemic-related pressures on the economy as a whole.
Opportunities and Risks Ahead
We continue to see opportunities for investment within the relatively lower valuation of international stocks as well as domestic stocks driven by continued solid earnings for US companies, which could accelerate if the economy continues to improve.
Even though the median inflation projection has risen to 2.2%, the updated inflation outlook doesn’t suggest there’s much overheating at the moment. Furthermore, economists’ estimates for median growth projections for 2022 and 2023 haven’t moved much. That situation, however, could change. Some researchers are criticizing the Federal Reserve for being too relaxed about the effects of inflation.
Other potential risks are high stock market valuations and speculative activity. There are many signs that this activity is already happening, such as increased trading in high-valuation companies that don’t actually have any earnings (so called “SPACs” or “blank check companies”) and in cryptocurrencies. As always, we’re keeping a close eye on risks, and we’ll continue to navigate them appropriately as we build and monitor individual portfolios.
There’s good reason to believe that the economic recovery is accelerating, and we’ll be seeking out opportunities this presents for you within your overall financial plan. At the same time, the upheaval and subsequent recovery during the Covid-19 pandemic demonstrates the importance of sticking to a goals-based investment allocation. Together, we’ll continue to tailor your plan to suit your unique financial objectives and a risk level you are comfortable with. Thank you for your confidence in our team.
If you’d like to talk about any of the issues raised in this edition of Windsor Perspectives, or indeed any aspect of your plan, please contact us.