First Quarter Market Review
“If you spend more than 14 minutes a year worrying about the market, you’ve wasted 12 minutes.” ~ Peter Lynch (from the book One Up On Wall Street)
Exactly one year ago, global markets were in a tailspin. Everyone from market participants to government officials worried about the future of an economy that completely stopped in its tracks. In the book One Up On Wall Street, legendary mutual fund investor Peter Lynch describes his success in relation to his inability to predict the future. In a PBS interview, Lynch stated how incredibly tough it was to be an investor in the early 1980s. Markets were facing persistent double-digit inflation, had endured nine recessions since World War II, and equity markets were in free fall. While his portfolio holdings declined in value, Lynch stated he didn’t see any of these factors being predicted in advance, much like the effects of COVID-19 on markets was not known in advance. However, the quote above reminds us of the steady mindset and temperament needed to succeed in the financial markets in times of market uncertainty.
In just one short (but very long) year, markets are on the upswing. There are periods of time when financial markets seem less uncertain – almost anticipated in advance – and the first quarter was one of those periods. A continuation of improving coronavirus trends, rapid deployment of vaccines, and massive fiscal and monetary stimulus kept the “reopening theme” alive and well. In the U.S., over 150 million doses of vaccines were administered, with almost four million doses given per day. With the prospect of a rapid return to life as we once knew it and the associated economic boom that comes with pent-up demand, all four major U.S. indexes were positive for the quarter (Dow Jones, S&P 500, Nasdaq, and Russell 2000). The rotation from stocks that were winners during the pandemic (growth-oriented stocks) to stocks that resembled reopening plays (value-oriented stocks) continued this quarter. All S&P 500 sectors were positive on the quarter. However cyclical sectors showed leadership with energy, financials, industrials, and materials as the clear standouts.
The quarter started out fairly strong as Democrats’ surprise victory in Georgia set the stage for full control of Congress and heightened expectations for fiscal stimulus to fight the coronavirus. Congress passed the $1.9 trillion coronavirus relief package with talks of another $4 trillion in additional spending, of which $2.25 trillion would be earmarked for much-needed infrastructure. Massive liquidity in the financial system paired with pent-up economic activity forced many projections for U.S. economic growth higher than the initial 5-6% GDP growth many expected, with some estimates as high as 7-8%. Earnings revisions for the first quarter and full year have trended higher as well. The fourth quarter of 2020 showed a positive earnings growth surprise, while S&P 500 earnings growth in the first quarter of 2021 is forecasted as high as 23%, a figure not seen since 2018.
Bonds across the globe came under pressure as interest rates moved higher and inflation expectations rose in anticipation of accelerating growth. The speed and magnitude of the move in interest rates seem to be the main story this quarter, which was reflected in first quarter bond returns. In fact, asset manager Blackrock published research stating that the first-quarter of 2021 was the second worst start for bonds going back 95 years, with only 1980 registering the worst return at almost -9%. Near-zero interest rates leave little cushion for investors to absorb interest rate shocks as low bond coupon rates typically help to mitigate interest rate volatility. However, the ten-year Treasury has moved from about 0.50% in late August to almost 1.8% this quarter, forcing bond prices lower in a fairly expeditious manner. Most major bond indexes were in low to mid-single digits in the quarter, with long-duration government fixed-income indexes down close to -14%. If there’s a silver lining to interest rates going higher, it’s that yields earned on bonds also go higher over time, providing increasing levels of income and future return potential.
Our investment committee is comprised of individuals with deep investment expertise whose gut reaction to “it seems too good to be true” tends to be, “it’s too good to be true.” We are a skeptical lot. So, when it seems as though investment returns are easy to come by, our antennas go up. March 23rd, 2020 marked the low point of the pain we felt in financial markets due to the fallout of Coronavirus. Exactly one year later, the S&P 500 increased 78%, the Russell 2000 increased 120%, while developed international and emerging market indexes were up 66% and 76%, respectively. The eye-popping returns only tell part of the story. In just one short month (from February to March of 2020), the S&P 500 declined close to 34%. As we know from our grade school math, markets must return almost 52% just for investors to get back to even. Looking at just the S&P 500 index, not only did investors get back to even, but they also increased their wealth by almost 20% by staying the course and taking the good with the bad. Inevitably, the best days in the markets are on the backs of the market’s worst days. As Peter Lynch aptly stated, worrying about the markets would have gotten us nowhere but focusing on what we can control—buying high-quality companies at reasonable prices while partnering with capable and like-minded investment managers—is the best formula for long-term investment success.
While it was a market indigestion level that makes even professional investors wince, it is even more justification as to why we create globally diversified portfolios for clients. By not suffering the full brunt of a market downturn, our ability to participate in the inevitable upside in financial markets helps us turn “one step back” into “two steps forward.” While we would not be surprised to see markets correct in the near term given the returns we have experienced over the past year, what will not surprise us is the way in which resiliency and perspective is built into client portfolios. We thank you for your continued trust and support of Madison Wealth Management. And we are here for you.