Summary:
- Tax incentives and the introduction of vaccines far exceeded expectations at the start of 2021
- Stocks weathered bouts of volatility and the Dow and SPX made new highs
- 10-year UST rates rose 83 basis points in the first quarter, the largest net income since the fourth quarter of 16
- The value exceeded growth in the first quarter by ten percentage points, the largest in 20 years
- Commodity prices were slightly lower as the greenback rose for the third straight year
- The S&P 500 corporate earnings are expected to grow 23% in the first quarter
Despite a volatility that surfaced at the end of the quarter, U.S. stock markets rose in the first quarter of 2021 due to two overarching themes – higher than expected – stimulus and vaccine progress. The late 2020 incentives ($ 900 billion) and the aid package signed in early March ($ 1.9 billion) represent nearly 14% of US GDP. The American employment plan, announced on the last day in March, provides for additional spending of $ 2.25 trillion, primarily aimed at improving transportation, communications and energy infrastructure. The infrastructure plan is combined with additional spending of $ 1 trillion on social programs and is expected to be released in April. Time will tell how much incentive Congress will give. However, total household spending is unprecedented and significantly higher than the prices set by the markets at the start of 2021. To fund the infrastructure plan, the Biden government proposed raising the corporate tax rate from 21% to 28%, which, by an estimate, could cost 9% of next year’s S&P 500 profit.
The largest vaccine rollout in history is underway, with more than 590 million doses administered worldwide. Bloomberg estimates that more than 150 million doses have been administered in the US, exceeding the total number of positive cases since the pandemic began. In the past week alone, an average of 2.8 million doses have been administered each day, and the government hopes to have enough supplies available to all adults in the US by the end of May. While cases are increasing around the world, including a recent surge in the US, the average vaccination rate far outstrips the surge in new cases.
Federal Reserve Chairman Jerome Powell sent an economic update to the House Committee on Financial Services and reiterated the central bank’s commitment to support the recovery. Powell expressed limited concern over recent capital market volatility due to the well capitalized banking system and reiterated the Fed’s stance on monetary stimulus. Making it clear that significant progress will be required before changes are made to the asset purchase program, he noted that the FOMC will withdraw support very gradually and with great transparency once the economy has recovered almost completely . He also sees the sharp rise in interest rates as an “orderly process” and as a sign of economic confidence.
Against a backdrop of increased volatility, the Dow (+ 6.8%) and S&P 500 (+ 4.7%) ended their best month since November, with each benchmark making new highs in the past week. The Nasdaq 100 lagged a modest 0.5% as growth stocks came under pressure from the sharp rise in interest rates. The Russell 1000 Value Index (+ 5.7%) outperformed the Russell 1000 Growth Index (+ 4.7%) by four percentage points, after outperforming it by six percentage points in February. The outperformance in February was the largest since March 2001.
The first quarter continued the trend that began in October with a rotation from growth to value and from large-cap to small-cap. Russell Microcap (+ 23.9%), S&P Midcap 400 (+ 13.5%) and Russell 2000 (+ 12.7%) were the top performers in the quarter. The Russell 1000 Value Index (+ 10.7%) outperformed the Russell 1000 Growth Index (+ 0.7%) by 9.9 percentage points, the largest outperformance in 20 years.
The relative strength chart below shows the weekly value to growth ratio (blue line) and its 40-week simple moving average (SMA). The 40-week SMA (purple line) is a preferred metric for longer periods of time as it is synonymous with the widely used 200-day SMA. In March, the spread of the ratio to the 40-week SMA rose to more than 10%, which has not occurred since the early 2000s, when Value began a multi-year trend of outperformance.
At the sector level, defensive utilities (+10.5) and Staples (+8.2) rallied strongly, bringing both groups into positive territory for the year. REITs (+ 6.4%) had their best month since November, playing in the green for five consecutive months. The cyclicals remained strong, led by industrials (+ 8.9%), materials (7.6%) and financials (+ 15.9%). Energy (+ 2.8%) slowed its breakneck pace with a relatively modest gain. For the quarter, energy (+ 30.8%) and finance (+ 5.8%) are the only two sectors in double digits.
Rates, Commodities and the Dollar:
Long rates exploded higher in the first quarter and the UST 10YR yield rose 15 basis points (January), 34 basis points (February) and 34 basis points (March). The 83 basis point increase in the first quarter was the largest quarterly gain since the fourth quarter of 2016 (85 basis points) and the second quarter of 2009 (87 basis points). Accordingly, the yield curve steepened significantly with the 10YR-2YR UST spread, which widened by 79 pounds sterling in the first quarter. While this is the highest increase since the first quarter of 2008, which almost marked the start of the Great Recession, the previous highs in the early 1980s came in the early stages of a historic bull market.
The following chart of the UST 10YR yield (monthly period) shows the long-term rate, which is easily beat by the expected long-term resistance in the 1.32% to 1.43% range (arrows), the previous large lows of 2012, 2016 and 2019 represented. Many eyes are looking towards 2% as the next stop; In the longer term, however, the level of ~ 3% appears more significant from a technical point of view.
The US dollar index (DXY) rose for the third month in a row, up 2.6% in March. Similar to long rates, this was the best monthly performance since November 2016. The most recent low in January bottomed near the 2018 lows, but the 12-month trend of lower highs persists. Price has recently moved back above the 40-week SMA, so what to see is what it can do from here.
The strength of the dollar proved to be a headwind for commodities. The Bloomberg Commodity Index (BCOM) was down 2.2% after five consecutive months in the green and gains for nine of the previous ten months. WTI crude oil declined 3.8% and copper 2.4%. Precious metals remain soft, with gold falling 1.5% and declining in seven of the last eight months.
The earnings season is just around the corner and expectations are high. According to FactSet, the estimated EPS growth rate for S&P 500 companies in the first quarter is 23.3%, above the 15.8% growth forecast expected at the beginning of the quarter. The previous high was in the third quarter of 18, when earnings rose 26.1%. Analysts are forecasting double-digit earnings growth for all four quarters of 2021. Revenue is expected to grow 6.3%, up from a forecast of 3.9% at the beginning of the quarter. According to Bloomberg, the 12-month P / E for the S&P 500 at the end of the first quarter was 22.7, which is well above the 5-year (17.8) and 10-year (15.9) averages .
While ratings are significantly higher than historical norms, the current environment is unlike anything our generation has ever seen. Massive fiscal incentives (25% of GDP) and increased adoption of vaccines (30% of the US population) are bigger and faster than expected at the start of 2021 just three months earlier. Accordingly, the economic data and future forecasts continue to improve. US GDP is expected to grow the fastest (7%) since 1984, with unemployment expected to drop to 5% by the end of 2021. The recent surge in Covid cases is far outweighed by the average vaccination rate. While the road ahead is sure to be bumpy, the reopening of the economy and historic economic stimulus should continue to support equity markets.
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