Standard & Poor’s 500 (S&P 500) Index’s first quarter 2021 performance of 5.8% has contributed to the index being up 19% from its pre-pandemic peak. This is the fourth consecutive quarter of positive performance for U.S. domestic equity markets. All S&P 500 sectors exhibited positive performance this quarter.

There was some sector rotation throughout the quarter. Segments of the economy that underperformed last year are among the best performers so far this year. Energy was up 30.9% in the quarter after declining 33.7% during 2020. These gains came as demand for underlying commodities picked up. The end of pandemic-related lockdowns is leading to increased mobility. There is an expectation for continued travel, and thus demand for oil. OPEC production cuts, which contributed to limited supply, are expected to start rolling off during the second quarter. Producers will be increasing production and that may keep prices relatively flat over the next few months.

Financials, the third-worst performing sector last year, was the second-best performing sector in the first quarter as it was up 16.0%. Banks were expecting the worst when it came to the pandemic. As a result, major provisions were made for prospective loan losses. Actual losses appear narrower than anticipated, leading to more profits being realized.

Real Estate, another sector that underperformed last year, saw strong returns distributed across multiple subsectors. Retail and Hotel REITs saw a comeback in first quarter after a difficult 2020. These subsectors were up 21.4% and 15.2%, respectively. Office REITs continue to struggle on a relative basis.

Companies with smaller market capitalizations outperformed their larger counterparts this quarter. The MSCI USA Small Cap Index was up 12.5%.

Developed and emerging markets lagged U.S. domestic markets. The developed market index, MSCI EAFE, was up 3.5% while the emerging market index, the MSCI EM, was up 2.3%.

The Value/Growth Dance
Another factor that continues to see a comeback is Value. In the first quarter, Value, as measured by the MSCI USA Value Index, was up 9.7%. Growth, using the MSCI USA Growth Index, was flat at 0.5%. The aforementioned outperforming sectors in the quarter are sectors that were beaten down last year. The Value benchmark has a 19% allocation to the Finance sector, a 5% allocation to Energy and a 4% allocation to Real Estate. This compares with the Growth allocations of 2.0%, 0.2% and 1.2%, respectively.

The rotation comes in the midst of high valuations for growth companies. Stock prices for growth companies have accelerated far ahead of their earnings. The price-to-earnings ratio for the next 12 months on the MSCI USA Growth Index was at 33.8x on March 31. This is down from 36.9x at the beginning of January.

To add a little context, the five-year average is 23.3x and the 10-year average is 20.2x. The Value index, on the other hand, closed the quarter at 17.3x. This is right in line with where it closed at the end of 2020. The concern in regard to the Growth realm is even if we continue to see earnings grow, the growth may not be enough to justify the prices we are seeing.

The Next Few Quarters
Valuation will continue to be a theme in the next few months. S&P 500 earnings are expected to grow approximately 24% in 2021. Flattening stock prices will contribute to fairer market valuations. Parts of the Industrials and Materials sectors are expected to benefit from a governmental focus on infrastructure. Margins may expand in Financials considering the likelihood we have hit the interest rate floor and there is some room on the upside for rates.

The high valuations relative to expected growth lead us to remain cautiously vigilant on equity markets.

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.

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