Hitting on All Cylinders
With the recent one-year anniversary of the equity market indices’ pandemic driven lows, it seems appropriate to review what has transpired since that momentous event.
The recovery exhibited by the U.S. equity markets over this time period has been nothing short of astounding. From the low established on March 23, 2020, to the end of the recently ended first quarter of 2021, the Standard & Poor’s Index returned 80.7%. Small cap stocks, as measured by the Russell 2000 Index, were even more impressive with a return of 117.6% over the same time period.
Economic performance, fueled by fiscal stimulus and easy monetary policy, has been equally impressive. The third and fourth quarters of 2020 registered GDP growth rates for the United States of 33.4% and 4.3%, respectively. Looking forward, there is an expected growth rate of 4.7% for the first quarter of 2021, according to the consensus of economists surveyed by Bloomberg. Comparably, the unemployment rate has seen tremendous improvement as well, declining to a current level of 6.0% from a peak of 14.8% in April of 2020. Contributing to the decline in the rate of unemployment was an unexpectedly strong increase of 916,000 in non-farm payrolls last month.
Other various metrics of activity illustrate the current level of strong economic growth in the United States. The Institute of Supply Management (ISM) indexes that provide a measure of economic activity for the manufacturing and service segments of the economy have both registered very strong results in their latest surveys. For the manufacturing segment, the index’s latest reading was its highest since December 1983. And, not to be outdone, the recently released non-manufacturing survey recorded its highest reading in the history of the survey, which dates back to 1997.
The financial health and mindset of the U.S. consumer are also key determinants of economic growth, as the goods and services they purchase account for approximately 70% of overall GDP. Currently, the U.S. consumer is in an excellent position to continue its strong role in GDP growth. The ability to spend is immense as stimulus programs have contributed to a current personal savings rate of 13.6% and helped create an increase in personal income of 6.1% in 2020. In addition to the consumer’s ability to spend is their willingness to spend, which is being boosted by a strong level of confidence in the economy. Like the ISM indexes previously mentioned, the recently released measure of consumer confidence announced by the Conference Board hit its highest level since March 2020 and had its biggest monthly increase since April 2003. The confluence of these factors has led us to raise our estimated range of GDP growth for 2021 to 5.5-6.0%.
Global economic growth is also projected to strengthen with the International Monetary Fund forecasting an increase of 6.0% in 2021. The highest levels of growth are anticipated to be in countries such as China and India, but more established economies like those in Europe are also expected to experience meaningful increases.
With the economy in full speed ahead mode, some circumspection is needed to evaluate what could slow or derail the impressive momentum we currently have. There are three prospective sources of friction that could potentially force the economy to shift to a lower gear: higher interest rates, increasing inflation and changes in tax policy.
Regarding the prospect of higher interest rates, the Federal Reserve has been very consistent in its messaging that it currently has no intentions of raising short-term rates through 2023. And with the substantial increase in longer-term rates already seen this year, we do not anticipate significant additional increases going forward.
We do anticipate an uptick in the rate of inflation as the year progresses. This reflects the release of pent-up demand associated with a reopening economy, combined with supply shortages across various industries. On a longer-term basis, the forces that have kept inflation at the modest levels we’re experiencing will re-exert themselves and bring inflation back down to those levels.
The prospect of increasing tax rates is being discussed, particularly using the additional revenue to pay for proposed infrastructure expenditures. With midterm elections less than two years away and very slim Democratic majorities in Congress, the probability of significant tax hikes is most likely somewhat muted.
There are two more potential speed bumps that could slow the economic momentum currently in place – either a resurgence in coronavirus cases or the failure of vaccines to effectively protect individuals from the multiple variants spreading across the United States. While cases have been increasing recently, the vaccination pace has accelerated to an average rate of over three million doses per day. Thus far, the efficacy of the vaccines being administered is producing the desired results.
Asset Allocation Review & Outlook
A major shift that began last year pertaining to a performance discrepancy favoring value stocks versus growth stocks continued into the first quarter of 2021. However, the net result at the aggregate level was consistent with the prior period, a strong showing by U.S. equities. While the first quarter’s return of 6.4% for the Russell 3000 Index of domestic equities was substantially lower than the 14.7% return realized in the previous quarter, it still propelled the returns for our balanced and growth-oriented investment objectives into positive territory for the period. The returns generated by international equities, as evidenced by the MSCI EAFE Index, were not as robust as the returns seen from U.S. markets. However, at 3.5% returns still made a solidly positive contribution to the equity component performance of our investment objectives. With the increase in interest rates seen in the first quarter, fixed income returns dipped into negative territory with the return from the Bloomberg Barclays Aggregate Bond Index providing a return of -3.4%.
The strong performance of global equity markets combined with the increase in interest rates that occurred during the first quarter has intensified the ongoing scrutiny of our allocation positioning. With increasing stock prices comes increased valuation levels that can potentially diminish the attractiveness of equities. With continued strong economic growth comes the potential for further increases in long-term interest rates, that negatively impact fixed income returns and create a stronger level of competition for investor dollars relative to the equity markets.
At present however, we are continuing to maintain our allocation positioning with an overweight to U.S. equities, neutral stance on international equities, and underweight to fixed income for client portfolios utilizing balanced and growth-oriented objectives. As we contemplate our current allocations, we are evaluating not only the representation of the various asset classes within each objective, but the representation various sub-categories have within each of those segments as well.
Given the recent performance provided by financial assets, we recommend investors do some contemplation as well. Investors should review their current investment objective to ensure it continues to be appropriate given their respective time horizons and risk tolerances.
Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet, Refinitiv.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
The information within this document is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and you should not interpret the statement in this report as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.