Q1 2021 Investment Overview

Increasing vaccination rates and pent up demand could signal a summer of brisk growth, but much depends on our success in controlling the coronavirus.

Market Summary

U.S. Markets Continue Upward Momentum

  • The S&P 500 gained 6.2% during the first quarter to reach new all-time highs. Markets pushed higher, undeterred by a swift rise in the 10-Year Treasury yield, as optimism about vaccination progress and ultra-accommodative fiscal and monetary policy continued to support market prices.
  • During the first quarter, the rotation of market leadership from large-cap growth stocks to value and small-cap stocks continued. The small-cap Russell 2000 Value Index climbed 21.2% in the first quarter, while the large-cap Russell 1000 Growth Index returned 0.94%.
  • The rotation of market leadership by sector also continued as companies leveraged to an economic recovery performed well. Energy stocks within the S&P 500 gained 31% in the first quarter, while Information Technology stocks returned 2%.

International Markets Lag U.S. Market

  • Equity markets outside the U.S. underperformed the S&P 500 during the first quarter as many countries fell behind in the global vaccination effort. Developed international equities as measured by the MSCI EAFE Index finished the first quarter up 3.6%. Emerging market equities as measured by the MSCI EM Index ended the first quarter up 2.3%.
  • Recent international market performance relative to the U.S. was stifled in the first quarter as the U.S. vaccination effort outpaced many global peers, some of which suffered from additional lockdown measures. In addition, the U.S. dollar’s rebound from fourth quarter lows provided another headwind to international stocks.

Fixed Income Challenged in Q1

  • Fixed income markets lost 3.4% during the first quarter, as measured by the Bloomberg Barclays U.S. Aggregate Index. A surge in 10-Year Treasury yields created uncertainty in the bond market, rising from 0.9% on 12/31/20 to 1.7% at quarter end.
  • Negative yielding debt receded from the fourth quarter’s all-time high of $18 trillion, but at around $14 trillion, remains historically high. Fixed income spreads also remain historically tight, while default risks appear to be stabilizing as further stimulus permeates the financial system.
  • The Federal Reserve reiterated its intention to maintain low rates and its commitment to purchasing $120 billion of bonds monthly. Its revised target of 2% average inflation implies that monetary policy will likely remain stable until inflation runs “hotter.”

Commodity Recovery Pushes Ahead

  • As measured by the Bloomberg Commodity Total Return Index, broad-based commodities returned 6.9% during the first quarter as global economic reopening boosted demand prospects.
  • Oil prices climbed during the first quarter, ending at $59.2/barrel. Agriculture and industrial metals also performed strongly in the first quarter, up 6.8% and 7.5%, respectively, as measured by the Bloomberg Agriculture and Industrial Metals Sub-indices.
  • Gold took a hit during the first quarter, losing 9.8% as rising yields and a turnaround in the U.S. dollar served as headwinds.

Investment Update

COVID-19 is Still the Story, But the End is On the Horizon

Even as the economic recovery from the worst of the COVID-19 pandemic gains further traction, the virus continues to drive recent market performance and at least the short-term outlook. The trends continue to be encouraging, but optimistic projections for the near future hinge on continuing to gain firmer control of the virus and on further success of the vaccination campaign.

The overall domestic case rate is down significantly from the winter. However, it is still higher than at points last summer in aggregate, driven mainly by major surges in particular areas instead of a broader surge as in late 2020. In California, the positivity rate as of April 26 was just 1.2%, the lowest the state had seen in a year1, and the case rate was just 33 new cases per 100,000 people. Meanwhile, Michigan’s positivity rate sat at 11.4%, with over 360 cases per 100,000.2 The national numbers look much closer to California than Michigan. Still, it stands as a reminder that reaching the light at the end of the pandemic tunnel requires continued steady progress.

That said, there is significant reason to believe that optimism is warranted. Despite a bumpy start, the vaccination rollout has improved significantly since the early days. After early struggles with limited eligibility for the vaccine and even more limited supply, all Americans over age 16 are now eligible, and we are beginning to see reports of availability outpacing demand. As of April 27, 42.38% of people in the U.S. have received at least one dose, while 28.93% are fully vaccinated.3 While it is somewhat of an open question as to the point at which herd immunity would be established, and to what degree those who have already contracted the virus and recovered from it contribute to that immunity, vaccination rates alone are a major driver of our progress towards something like normalcy. Beyond suppressing infection rates and providing the ability to reopen safely, higher vaccination rates are likely to make a larger percentage of people feel confident about going out, scheduling long-awaited vacations and generally doing the things they haven’t been doing over the past year, giving hard-hit sectors like hospitality a needed boost.

Immunity Effort Continues to Accelerate

Source: JPMorgan

As the U.S. continues our steady progress towards the end of the immediate COVID-19 crisis, rampant outbreaks abroad, particularly in places like Brazil and India, remind us that we have a long way to go before we turn the tide against the virus on a global basis. The suffering in many countries is not only a humanitarian crisis with a staggering and growing human cost, but a potential economic one as well. If the worst of the pandemic continues in other parts of the world, we do still stand to see knock on effects domestically if, for example, there are supply chain issues that arise as a result.

The Healing Continues

The expanding reopening of businesses across the country has allowed many people laid off over the past year to return to work. The overall unemployment rate is still elevated relative to pre-pandemic levels but has returned to relatively normal levels from a historical perspective.

Unemployment Rate as of April 2021

Source: Charles Schwab. Red indicates a recognized recession.

The gap between the official unemployment and U-6 unemployment, which includes those who are underemployed, has narrowed compared to a year ago. As businesses are able to rehire workers laid off due to the effects of the pandemic, ideally, some of those who are currently considered underemployed and counted in U-6 begin to return to full employment as conditions improve, particularly those in the service sector who stand to see the most significant benefit from broader reopening and expanded capacity.

Recovery across sectors is still understandably uneven, given the varied impacts that the pandemic has had. Still, spending is strong as measured by consumer transactions, and across sectors we see a largely positive trend. Sectors like hospitality and travel are still somewhat significantly below pre-pandemic levels but stand to gain the most in the short term from a summer travel season that sees vaccinated people enjoying much-delayed vacations and evenings out.

Recovery Across Sectors

Source: JPMorgan

Manufacturing numbers, another indicator of the progression of the recovery, are continuing their rebound and then some, having exceeded pre-pandemic levels. And importantly, we see both the manufacturing and service sector Purchasing Manager Indices (PMI) moving in sync in recent months, indicating a broader recovery than during some of 2020. While much is still dependent on improving conditions around COVID-19 and growing vaccination rates, the current trends are broadly positive.

Manufacturing & Service Sector Purchasing Manager Indices (PMI)

Source: Bloomberg

Globally, household savings rates have experienced a recent spike, indicating pent-up demand still waiting to be unleashed as reopening continues. This could also help contribute to a summer of higher spending and strengthening economic performance. It is also worth noting that a key piece of the puzzle around domestic savings rates is that the direct payments included as part of the stimulus packages over the past year have done their jobs, providing an income boost to allow ordinary people to keep their heads above water and even be able to plan for non-essential spending in the coming months.

Household Savings Rates

Source: Bloomberg

Continued Strong Earnings for Resilient Sectors, While Cyclical and Small Companies Join Rebound

We expect continued strong earnings growth from the more resilient sectors such as technology and healthcare that fared better than many parts of the economy during the pandemic. Growth for technology companies that have performed well over the pandemic, thanks to the shift to work from home and increased dependence on things like streaming services and online shopping, shows little sign of slowing. But it is significantly buoyed by the biggest players like FAAAM (Facebook, Apple, Alphabet, Amazon and Microsoft), whose market capitalization is as high as ever.

More recently, earnings expectations for more cyclical and smaller companies who suffered more during the downturn have begun to improve. Energy, one of the hardest-hit portions of the market over the past year, is continuing to recover and is a sector that stands to gain meaningfully with a summer travel season leading to increased fuel demand. And we believe that there remain some attractive opportunities in small-cap equities where there is still robust growth potential.

2021 S&P 500 Earnings Per Share (EPS) Estimates

Source: SSGA; FactSet as of 3/31/21

Potential earnings growth also appears stronger in global markets than in the U.S., an important reminder that the experience of the pandemic has varied around the world and that markets in different regions will present different opportunities over the rest of the recovery.

Inflation, The Deficit and The Federal Debt All Bear Watching

One of the expected consequences of the improving economic recovery is an increase in inflation, and a range of indicators bears this out. The Consumer Price Index is trending upward, indicating rising prices for consumer goods, and the yield curve has steepened, indicating not just what we are currently experiencing but that it is broadly expected going forward.

U.S. Inflation Expectations

Source: Bloomberg

Inflation is unsurprising and is a natural side effect of the recent economic trends. From an investment perspective, however, the primary concern is that this inflation rate makes real treasury yields negative (after adjusting for inflation). And if one looks at the gap between equity yields (the inverse of the price/earnings ratio) and fixed income yields, while it has narrowed somewhat recently, equities are still more appealing in many cases, given the outlook for inflation. As a result, we will continue to underweight fixed income in favor of other options until fixed income yields look more promising.

S&P 500 Forward Earnings Yield vs. 10-Year Treasury Yield

Source: Bloomberg

The growing federal deficit and level of debt relative to GDP also bear watching. According to a Congressional Budget Office report released in March, before the passing of the most recent $1.9T stimulus package, the budget deficit is expected to stand at 10.3% of gross domestic. This represents the highest level since the immediate aftermath of World War II.4 The good news is that the short-term outlook is positive. The deficit is expected to decrease precipitously over the next several years as business continues to recover and make up for lost gains from the past year. More concerning is the long-term outlook. A combination of the costs of the massive stimulus packages needed to weather the pandemic and growing costs of health care and Social Security for a growing population could lead to the need for either austerity measures and/or increased tax rates down the road.


Building on the progress of the past few quarters, the recovery from the impact of the COVID-19 pandemic continues. While indicators are broadly positive, much hinges on the success of further suppressing the virus and expanding vaccinations to reach a level of broad immunity. The bounce back from the worst of the market downturn is not without cost, however, as the growing deficit may make for difficult choices in the long-term. In the short term, at least, we expect a broadening recovery as we approach something close to normalcy.

1Gavin Newsom. April 26, 2021. <https://twitter.com/GavinNewsom/status/1386765423044034565>
2Centers for Disease Control. “COVID Data Tracker.” April 26, 2021. <https://covid.cdc.gov/covid-data-tracker/>
3Our World in Data. “Coronavirus (COVID-19) Vaccinations.” April 28, 2021. <https://ourworldindata.org/covid-vaccinations>
4New York Times. “Mounting federal debt puts the U.S. at risk of a fiscal crisis, Congressional Budget Office warns.” March 4, 2021. <https://www.nytimes.com/2021/03/04/business/cbo-deficit-projection.html>


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