April 12, 2021
U.S. and International Equities
This quarter provided positive results for all major market indexes. The top performer and standout was the US small cap Russell 2000, returning over 12% for the quarter. The international developed and emerging markets, as denoted by the Morgan Stanley Capital International (MSCI) Europe, Australasia, Far East (EAFE) and Emerging Markets (EM) indexes, both finished the quarter higher.
Energy, Financials and Industrials show Double-Digit Returns
The energy sector, which started its rebound during the fourth quarter of last year, returned over 30% this quarter leading all sectors. Oil prices gained more than 20% as the global demand outlook has improved and the COVID-19 vaccine rollout has accelerated quicker than expected.
Financials also had a solid quarter, returning 16%. The sector benefited from improved growth prospects and a steeper yield curve.
Industrials outperformed amid the reopening trade, despite a strong dollar in Q1. The sectors that did well during the pandemic, the “stay at home” sector (information technology) reversed course and lagged the S&P 500 Index this quarter along with defensive sectors like consumer staples.
Earnings, Earnings, Earnings
One major factor influencing the markets this quarter has been earnings. The S&P 500 Index earnings growth for the fourth quarter of 2020 increased more than 3% year-over-year. This was roughly 12 percentage points above the earnings decline expected coming into earnings season.
The sectors that saw the largest upside surprises include communication services, consumer discretionary, and financials. Forward 12-month estimates have impressively increased about 4% year to date.
“Our confidence in the economic recovery continues to grow, bolstered by vaccine distribution and fiscal and monetary stimulus,” according to LPL Equity Strategist Jeff Buchbinder.
Stock valuations are higher globally
As stock prices have gained, the S&P 500 forward price-to-earnings ratio (PE) has risen to over 21, roughly 35% above its 10-year average. When looking at the developed overseas markets, the PE for the MSCI EAFE Index is 17, which is 23% above its long-term average. In addition, the story for emerging markets (EM) equities is the same, with the MSCI Emerging Markets (EM) Index PE over 14. This is 27% above its long-term average. Despite the recent rise in interest rates, LPL Research continues to believe low interest rate levels support elevated valuations globally.
Japan’s Nikkei tops 30,000
The Japanese Nikkei recently topped the 30,000 mark. This is the first time that the Japanese headline index has seen that level in over 30 years. That being said, the Nikkei still has a ways to go in order to reach its all-time closing high of 38,915.87, which it achieved on December 29, 1989.
Quarterly Fixed Income Results
The benchmark Bloomberg Barclays U.S. Aggregate Index posted its worst quarter since 1981, hampered by a low starting yield and sharply rising rates. Municipal high yield, as denoted by the Bloomberg Barclays High Yield Municipal index, was a bright spot in March, returning over 2% for the quarter, aided by tailwinds from provisions in the fiscal stimulus package that included aid to state and local governments.
International bonds, denoted by the Financial Times Stock Exchange (FTSE) World Government Bond Index, and emerging markets debt, measured by the JP Morgan Emerging Markets Bond Index (EMBI), ended the quarter lower as rising bond yields were not limited to the US.
Bond yields are rising in anticipation of improved economic activity and higher inflation expectations. LPL Research recently increased and narrowed its year-end 10-year Treasury yield forecast to a range of 1.75 – 2.0%.
Commodities posted mixed results this quarter. Oil has been this year’s top performing commodity, returning 22%. In addition, natural gas returned over 2% this quarter. The metals were mixed, with silver and gold both giving back almost 10%. Copper was the standout metal this quarter, returning almost 14%.
U.S. Economic Data Recap
Inflation: Higher gasoline prices fueled both consumer and producer prices for the quarter. However, excluding volatile food and gas prices, inflation only rose slightly this quarter, with the core Consumer Price Index increasing marginally.
Quarterly producer prices, measured by the core Producer Price Index (PPI), increased the most since December 2009. Year over year, the February PPI increased over 2%. This shows that producers are having marginal success increasing prices as the economy tries to recover from the impact of COVID-19.
Inflation has risen slowly from the low levels seen in 2020 and should begin to normalize—although we believe any inflationary pressure will ultimately prove transitory.
U.S. Consumer: The Conference Board’s Consumer Confidence Index has improved this quarter and surged in March to its highest reading since the onset of the pandemic. The Present Situations Index also grew, reflecting the economic recovery.
In March, the University of Michigan consumer sentiment survey increased almost 10% to the highest level in a year after reaching a six month low in February. However, it is still below pre-pandemic level. The government stimulus has been credited for the increase in both consumer confidence measures.
Retail Sales: Following a strong January and a tepid December, February retail sales fell 3% month over month. This was below consensus, but largely attributed to weather disruptions.
U.S. Home Sales: Home sales surged to begin the year. Sales increased to their highest level since 2006 according to the National Association of Realtors, given pandemic driven demand. In addition, the inventory of homes for sale stood at just over 1 million at the end of January. This was the lowest inventory level since Realtors started collecting data in 1982.
February new home sales fell over 15%; however, they remained higher compared to a year ago. The weather was the primary culprit for the drop in home sales last month. Higher rates could also be a cause, but given tight inventories and demographics, the market should remain solid going forward.
Small Business Sentiment: The National Federation of Independent Business (NFIB) Small Business Optimism Index sits below its 47-year monthly average of 98 this quarter. The most recent monthly NFIB report showed some concern about a tightening job market and anticipation of increased price pressures, both signs of a recovering economy but also potentially new challenges. At the same time, muted sales and profit growth expectations limited the overall index’s improvement.
Federal Reserve (Fed) News: The Federal Open Market Committee (FOMC) voted to keep interest rates near zero and to continue its asset buying program of at least $120 billion in bonds a month. The central bank indicated that it did not expect to hike rates through 2023.
Moreover, the Fed also stated that it expected gross domestic product growth to reach over 6% this year and for core inflation to reach over 2%, with both measures then projected to settle next year. Those projections, combined with the expected path of interest rates, shows that the central bank is sticking to its plan of letting the economy run as the United States recovers from COVID-19.
Fed Chairman Powell noted that since the genesis of COVID-19 last spring, consumer prices partially rebounded over last year. However, pricing along with the employment picture remained soft in sectors most adversely affected by the pandemic last quarter. Fed policy is most likely going to depend on COVID-19 mitigation efforts in addition to how quickly the employment picture improves across all sectors, but especially the service sector.
In response to the recent rise in Treasury yields, Powell added he would be concerned with disorderly markets or a tightening of financial conditions that could threaten the path of the current economic recovery. Despite comments indicating that the Fed is a long way from pulling support from the economy, bond markets seemed concerned by how the Fed might manage the rise in long-term rates.
U.S. Employment: US non-farm payroll growth surged in March as the labor market added over 900,000 jobs. This beat the consensus estimate by over 250,000 jobs. Hospitality and leisure, construction, and education services witnessed the greatest gains. In addition, the labor force participation rate increased while the unemployment rate declined to 6%. This helps to confirm our view that stimulus paired with vaccination progress should lead to an expedited reopening of the economy and an improved employment outlook.
Market participants will continue to keep a close eye on progress with vaccination programs as well as changes in COVID-19 cases, particularly in light of emerging variants of the virus. Strong fourth quarter earnings were an important driver in this year’s market results so far, and first quarter earnings will be announced shortly. This trend needs to continue in order for equities to keep performing well.
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