Stimulus and Vaccine Optimism Power Markets Higher in the First Quarter
The first quarter of 2021 was marked by several macro- and micro-economic surprises that resulted in increased market volatility compared to the fourth quarter of 2020, but additional economic stimulus combined with accelerating COVID-19 vaccine distribution and a decline in coronavirus cases helped stocks start the new year with solid gains.
At times, first quarter reminded us of the volatility and unpredictable nature of markets in 2020; however, just like markets proved resilient last year, stocks overcame multiple surprises during the first quarter to provide another positive quarterly return.
1st Quarter Performance Review
Expectations of a post-COVID recovery drove performance in the first quarter, as the Dow Jones Industrial Average outperformed the S&P 500 and the Nasdaq 100 due to underperformance of technology shares.
By market capitalization, small-cap stocks, historically more sensitive to changes in economic growth, outperformed large-cap stocks as COVID cases declined and many states partially or fully reopened their economies. This led investors to expect a broad acceleration in future economic activity.
From an investment style standpoint, value outperformed growth over the past two quarters. Substantial outperformance by value stocks underscored increasing investor optimism for an economic rebound in the coming months.
On a sector level, all 11 S&P 500 sectors finished the quarter with positive returns. Cyclical sectors, including energy, financials, industrials, and materials led markets higher over the past six months. Again, expectations for accelerated economic growth, combined with higher bond yields and fears of potentially rising inflation, drove the cyclical sector outperformance in the first quarter.
Tech was one of the biggest sector laggards as investors rotated out of tech and into cyclical sectors to position for acceleration of economic activity expected as the economy reopens. Traditionally defensive sectors such as utilities, health care, and consumer staples also underperformed the S&P 500 on expectations of a strong economic rebound.
Commodities posted strong gains for the second quarter in a row and notably outperformed the S&P 500 over the past three months. Major commodity indices were led higher by a large rally in crude oil futures as investors anticipated increase in demand for both oil and refined products as the global economy begins to normalize. Gold, however, posted another quarterly decline despite fears of higher inflation, as a stronger U.S. dollar combined with rising popularity of alternative investments such as Bitcoin dampened demand for the precious metal.
Switching to fixed income markets, quarterly total returns for most bond classes were negative for the first time in over two years. Stimulus and vaccination distributions accelerated expectations for economic growth in the coming months, but also resulted in a surge in inflation estimates, which topped a five-year high in the first quarter and that weighed broadly on the fixed income markets.
Looking deeper into the bond markets, longer-duration bonds underperformed those with shorter durations in the first quarter. That substantial under-performance was driven by the Fed’s consistent promise to keep short duration interest rates unchanged while the market priced in higher future levels of inflation, which pressured bonds with longer-dated maturities.
2nd Quarter Market Outlook
As we begin the second quarter, market outlook remains positive. Fresh stimulus monies entering the economy on a personal, corporate and government level should spur economic growth in the months ahead.
Additionally, while COVID has surged recently in Europe, outlook for the U.S. remains positive. Vaccine distribution continues to accelerate, with the goal of having vaccines available to all adults nationwide by May. As a result, it is reasonable to think the pandemic will be declared “over” by early summer (although obviously COVID-19 inflections will continue, just not at a pandemic level that demands large-scale government response).
Outlook for the economic recovery remains bright, with improvement across multiple economic indicators, while the Federal Reserve has renewed its pledge to keep interest rates low and its quantitative easing (QE) program ongoing until the economy returns to pre-pandemic activity levels.
Those factors all provide substantial support for markets as we begin the second quarter. But as the first quarter clearly demonstrated, there are always risks that need to be monitored. First, rising bond yields caused volatility in late February through March, and if bond yields rise, we can expect more stock and bond market volatility as high interest rates are a threat to the economic recovery.
Similarly, investors expect inflation to accelerate as historically massive stimulus fuels the economic recovery. Right now, the Fed expects any rise in inflation to be temporary, but if that proves incorrect, they will have to remove stimulus by reducing the current QE program, and that is not priced into markets right now.
At Brixton Capital Wealth Advisors, we understand the risks facing both the markets and the economy. We are committed to helping you effectively navigate this still-challenging investment environment. Please contact us with any questions, comments, or to schedule a portfolio review.