May 2021
US Economy: Rapid GDP growth.
The US economy grew 6.4% annualized in 1st quarter 2021, on strong consumer spending boosted by federal Covid-relief payments. Although slightly below consensus, this was the fastest growth rate in decades. In the 2nd quarter, US GDP is highly likely to recover to its pre-pandemic level.
US Stocks: Earnings are good.
Investors had anticipated strong earnings for Q1 2021 relative to the lows hit last year during the pandemic, and the results so far have exceeded expectations. According to Factset, with 60% of S&P 500 companies reporting, 86% have announced positive earnings surprises. Given this backdrop, US stocks continued to rally.
Foreign Stocks: EMs struggle with Covid.
Emerging markets (EM) gained but lagged the US. As developed nations make progress against Covid-19, many major EMs are struggling. Still, certain EM markets, such as India (+2.3%) and Brazil (+4.3%), were up in April despite skyrocketing infection rates, as investors anticipate foreign aid and economic resiliency.
Fixed Income: Rate rise on pause.
After a dramatic rise through March, the 10-year US Treasury yield settled between 1.6% and 1.7% in April, with the Fed insistent that inflation is well-controlled despite consumer prices rising 2.3% year-over-year. Strong upcoming manufacturing and labor market data could restart the move to higher yields.
Real Assets: Commodities take off.
Commodities surged in April with the acceleration of economic activity. While oil returned approximately 7.5% during the month, industrial commodities such as copper (+12.3%) led the pack. Shortages amid a homebuilding boom have led to a dramatic rise in the price of finished lumber, which was up nearly 50% in April alone.
Alternatives: M&A burst.
Merger and acquisition activity has continued at a torrid pace reaching the highest level ever, as corporations flush with cash and private equity funds with “dry powder” seek investment opportunities. The trend is likely to continue given low interest rates and potential corporate and investment tax increases to motivate sellers.
Equities Total Return
| APR | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | 5.3% | 11.8% | 46.0% |
| U.S. Small Cap | 2.1% | 15.1% | 74.9% |
| U.S. Growth | 6.5% | 7.8% | 52.4% |
| U.S. Value | 3.9% | 16.2% | 47.8% |
| Int’l Developed | 3.0% | 6.6% | 39.9% |
| Emerging Markets | 2.5% | 4.8% | 48.7% |
Fixed Income Total Return
| APR | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | 0.8% | (2.6%) | (0.3%) |
| TIPS | 1.4% | (0.1%) | 6.1% |
| U.S. High Yield | 1.1% | 2.0% | 20.1% |
| Int’l Developed | 1.3% | (5.3%) | 3.6% |
| Emerging Markets | 1.7% | (1.6%) | 8.4% |
| Tax-Exempt | |||
| Intermediate Munis | 0.5% | 0.2% | 5.6% |
| Munis Broad Mkt | 0.9% | 0.6% | 8.3% |
Non-Traditional Assets Total Return
| APR | YTD | 1 YR | |
|---|---|---|---|
| Commodities | 8.3% | 15.8% | 48.5% |
| REITs | 8.1% | 17.1% | 33.4% |
| Infrastructure | 3.5% | 6.6% | 29.7% |
| Hedge Funds | |||
| Absolute Return | 1.5% | 2.1% | 9.2% |
| Overall HF Market | 1.8% | 3.1% | 14.9% |
| Managed Futures | 3.3% | 6.0% | 9.7% |
Economic Indicators
| APR-21 | OCT-20 | APR-20 | |
|---|---|---|---|
| Equity Volatility | 18.6 | 38.0 | 34.2 |
| Implied Inflation | 2.4% | 1.7% | 1.1% |
| Gold Spot $/OZ | $1769 | $1879 | $1687 |
| Oil ($/BBL) | $67 | $37 | $25 |
| U.S. Dollar Index | 112.4 | 116.5 | 122.6 |
Our Take
So far, so good. US economic growth appears to be accelerating as widely anticipated. Our base case is that well-above-trend growth will be driven by higher consumer spending, which makes up nearly 70% of US GDP. Consumer confidence hit 121.7 in April, the highest level in 14 years, while spending increased 10.7% in Q1, even as other components of GDP, such as exports, weakened. Continued recovery in the labor market plus ongoing support from the federal government (unspent Covid-relief, the proposed infrastructure legislation) will provide additional fuel. With nearly 60% of the US population having received at least one Covid-19 vaccine dose already, we are well on the way to 70% full-vaccination rate by this summer.
At this point, the key focus for investors is inflation and the extent to which interest rates rise. We think inflation will accelerate from here and rates are likely to rise further, but the magnitude of those moves is uncertain, and it is not a forgone conclusion that either data point will reach a problematic range.
We believe, as the Fed does, that accelerating inflation is likely to be mostly transitory and the resulting upward pressure on interest rates will be modest in the near term. This theory will be tested in the coming months given that inflation numbers have just recently begun to climb.
We see potential tax increases as another risk to the financial markets. While the near-term impact of higher government spending is likely to be positive, we are closely monitoring Congressional debate about increases to the corporate tax rate, personal tax rate and capital gains, to pay for new federal programs. Higher corporate taxes would hurt profits, while individual rates are a key consideration for how we structure portfolios for our clients.
What We’re Doing
We are pleased to see that the asset classes and sectors we thought would outperform in 2021 have done so, with equities easily outpacing fixed income being the overarching highlight. Within equities, we view cyclical stocks as the most promising given economic reopening.
Despite the upturn in Covid cases in key emerging markets, we think this space warrants an allocation given the longer-term growth potential and the likelihood of support from developed countries via excess vaccine supplies. While we always maintain some inflation-sensitive exposure to commodities and other real assets, we are reviewing that positioning to be better prepared should inflation accelerate more quickly and on a more prolonged basis than we anticipate.
