State of the Markets
The first quarter of 2021 was generally filled with positive news – vaccine rollouts, improving numbers related to COVID-19, another round of federal stimulus, and an overall trend of the economy heading back toward normal. The markets see the future as good, but the projection of a strong economy affects stocks and bonds differently:
- State of the stock market (as conveyed by a young, optimistic investment banker): Vaccines and herd immunity will get COVID-19 behind us. We think there’s pent-up demand. Everyone wants to do what they’ve missed in 2020 and more. A lot of the money coming from the government will wind up as corporate profits one way, shape, or form. Let’s do this!
- State of the bond market (presented by a conservative, belt and suspenders, bond analyst): Yes, the economy is expected to do well in 2021. While our cautious approach provided stability and great returns in 2020, we may have been too pessimistic in our long-term forecasts. Yields turned out to be too low and need to go back toward normal, just like the economy. Bond prices will adjust, and we will give back some of what we gained last year.
As of March 31, the global stock market (MSCI ACWI IMI) was up 5.1%. The U.S. stock market (Russell 3000) had positive performance of 6.4%. International developed markets (MSCI World ex USA IMI) rose 4.2%. Emerging markets (MSCI Emerging Markets IMI) returned 2.9%. Publicly traded real estate (S&P Global REIT) had a significant rebound of 6.2% for the quarter. The U.S. bond market (Bloomberg Barclays U.S. Aggregate Bond Index) was down 3.4% as bond yields rose and prices declined.
The total returns for major asset classes are below.
As mentioned, many times in the past, the return of various sectors within the market can vary widely. The recent trends within the stock market – small companies outperforming large, value outperforming growth – have continued (as evidenced in the chart below). This has driven significant outperformance of value focused strategies year-to-date.
On Our Radar
As an investor, it helps to be optimistic, but it also helps to be aware of potential risks and understand the variables that might impact the future in a negative way. While we don’t have significant concerns about the following subjects, we will share our perspective:
The Bettor’s Market
Within the last 12 months, there have been several irrational instances of speculation and manipulation within the markets. Included in the list:
- Significant increase in retail day-trading driven by apps like Robinhood
- Collusion and manipulation of stocks like GameStop and AMC
- The extensive issuance of special purpose acquisition company (SPACs), many of which are speculative in nature
- The rise in crypto currency, including Bitcoin, which may turn out to be legitimate, and Dogecoin, which certainly is not
- A tiny N.J. deli, which trades publicly with a valuation of $100M
While these instances have been great for the press and stimulating for day traders, they don’t necessarily have an impact on long-term investors.
Investing is not gambling, but let’s explain via a casino analogy. If you want to win at a Blackjack table, there are specific strategies you can implement. These strategies will maximize the probability of winning against the dealer. You won’t win every hand, but over a long period of time, you may beat the house. Now suppose halfway through your game, a boozed couple sits down next to you (this is a casino analogy after all) and makes some random, big bets. They win a few hands in a row and walk away with twice as many chips. Meanwhile, you have been there for hours, are following the rules to the letter, and are break even.
Does that mean your strategy is broken? No. Does it mean their strategy is brilliant? No. Random players (and traders) can win lucky bets in the short-term, and when they do, they get attention and envy. But strategies built on research and evidence win in the long-term. To make them work, you must be patient and committed. This applies to both Blackjack and investing.
Inflation is out there. It always has been, and always will be. The rate of inflation over the last 10 years has been hovering around 1.75% – relatively low and stable. The Federal Reserve’s current priority is supporting the economy with 0% interest rates, growing money supply, and willingness to let inflation rise to 2% or higher. Does this environment create significant inflation risk?
It definitely increases the probability of higher inflation; and we are seeing prices rise in some areas, but higher inflation is not always bad. Rising inflation driven by a strong economy and high consumer demand would not be a worst-case scenario. If inflation gets out of hand, the Federal Reserve could certainly adjust their policies as needed.
That said, we consider inflation to be the silent enemy, because it diminishes the value of your money, slowly but significantly, over time. Hedging against unexpected inflation can be part of an investment strategy by design. This includes shorter duration fixed income which is less affected by rising rates, emerging markets exposure which historically outperforms in high inflationary periods, and the real assets portion of the portfolio which includes businesses – real estate, infrastructure, and utilities – that can raise prices in inflationary environments.
Federal deficits and national debt are at all-time highs. According to the Congressional Budget Office (CBO), the 2020 deficit was $3.1 trillion, which increased federal debt to $27.7 trillion as of the end of 2020. CBO is forecasting that 2021 will be another year with lower tax revenue and increased spending resulting in a deficit just over $2 trillion. Thankfully, we were able to tap into our “credit line” for support during this pandemic, but these are not sustainable numbers.
The CBO forecast predicts that 2022 will see a return toward normal with deficits in the $900 billion range. To put this in perspective, a deficit at this level equates to roughly 4% of GDP, which is similar to what we’ve seen over the last several decades and a mirror image of 2018/19. (These CBO forecasts do not include any potential changes in tax law or spending, and there are problems, like social security that need to be fixed down the road.)
Despite our annual deficits, our country’s capacity for debt relies on two abilities – can we pay interest on outstanding debt, and can we issue new debt when old debt matures. Both of these seem very sustainable given low interest rates, global trade, and the U.S. dollar’s role as reserve currency.
While market manipulation, increased inflation, and expanding federal debt are not ideal, we don’t see them having a meaningful impact (yet) on long-term investment results.
As always, thank you for your trust and confidence. Please reach out if you have any questions.