04/19/2021

ECONOMY

The US economy has entered a new phase in its economic cycle. Just over a year ago, the country reeled from the impacts of the COVID-19 pandemic. For much of the past year, business activity has been significantly curtailed due to the severity of the pandemic. However, in the past few weeks the economy has begun to largely reopen. The CDC has loosened travel restrictions, restaurants are expanding in-person dining, movie theatres and other entertainment venues are reopening, and Disneyland will open again at the end of April. 

The impact of this “Great Reopening” is already showing up in several economic indicators. The US labor market added 916,000 jobs in March - the strongest employment growth since August 2020, with the unemployment rate dropping to 6%. Consumer confidence, which had languished since the beginning of the pandemic, rose to levels nearly indicating that people feel the economy is becoming prosperous once again. The US Gross Domestic Product is expected to grow as much as 6% in 2021. And a closely-watched survey from the Institute for Supply Management surged to a record high due to the positive impacts of increased vaccinations and federal stimulus on consumer demand.

While the economy is entering a period of strong growth, it’s success is still tenuous. Even though employment growth was strong in March, the labor market still has 8.4 million fewer workers than before the pandemic. And there are fears that strong economic growth may lead to much higher inflation than the current annual rate of 1.7%. Right now, the Federal Reserve is more concerned about restoring lost jobs than the possible impacts of high inflation, especially if it only turns out to be short-lived. But if this inflation becomes high (above 4%) or seems more permanent, they may be forced to increase interest rates to slow economic growth and bring inflation back down. Overall, the economy is gaining strength but still has some time to go before it can be called healthy again. 

The American Jobs Plan announced on the last day of March proposes an additional $2.25 trillion in spending geared largely toward improving transportation, communication, and power infrastructure. The infrastructure plan could be paired with an additional $1 trillion in spending focused on social programs and is expected to be unveiled in April. Time will tell how much stimulus will be passed by Congress; however, overall fiscal spending is unprecedented and clearly larger than what markets were pricing at the start of 2021. To fund the infrastructure plan, the Biden administration suggested hiking the corporate tax rate to 28% from 21%, which one estimate indicated could cost 9% of next year’s S&P 500 earnings.

Earnings season is soon upon us, and expectations are high. According to FactSet, the estimated Q1 earnings growth rate for S&P 500 companies is 23.3%, which is up from the 15.8% growth forecast expected at the beginning of the year. The previous high was in the third quarter of 2018 when earnings grew 26.1%. Analysts are forecasting double-digit earnings growth for all four quarters of 2021. Revenues are expected to grow 6.3%, which is up from 3.9% estimated at the start of the quarter. According to Bloomberg, the forward 12-month P/E ratio for the S&P 500 was 22.7 at the end of Q1, which is well above the 5-year (17.8) and 10-year (15.9) averages.

While valuations are meaningfully elevated versus historical norms, the current environment is unlike anything our generation has ever seen. Massive fiscal stimulus (25% of GDP) and stronger vaccine rollout (30% of the U.S. population thus far) are larger and faster than what most expected just three months ago at the start of 2021. Accordingly, economic data and future projections continue to improve. U.S GDP is forecasted to grow at its fastest pace (6%) since 1984, with unemployment falling towards 5% by the end of 2021. The recent rise in Covid cases is far outweighed by the average rate of inoculation. While the path ahead is sure to be bumpy, the reopening of the economy and historic stimulus efforts could continue to support equity markets.

Developed International equities (+3.5%) lagged U.S. equities as measured by the MSCI EAFE Index for the three-month period. The underperformance can be attributed to the fact that economic prospects are improving more slowly outside the U.S. due to a slower pace of vaccinations for Covid-19 and the policy mix is less skewed toward fiscal stimulus. Emerging Markets (+2.3%), according to the MSCI EM Index, also underperformed and can point to similar issues as well as a stronger U.S. Dollar during the latter part of the quarter which can create a headwind for emerging markets companies.

The sharp rise in bond yields translated into negative returns for most fixed income sectors of the market. Having an allocation to higher-yielding securities helped mitigate some of the losses as they generated positive results due to their higher yields helping offset price declines. Higher-quality municipal bond prices were not immune from the rise in interest rates and posted modest losses.

progress, while also focusing on risks and opportunities including interest rate sensitivity, increasing inflation expectations, and geopolitical tensions.  

Master Limited Partnerships (MLPs)

Ongoing focus on balance sheet management coupled with rising energy prices propelled MLPs higher during the first quarter. With the capital spending boom brought on by the Shale Revolution now behind them, companies are now focused on growing free cash flow, committing to higher return projects and share buybacks.  

Real Estate (REITs)

REITs generated a second consecutive strong quarterly showing led by a rotation to value and reopening economy companies including Malls and Shopping Centers followed by Hotels. These sectors were 

the worst performers in 2020 and have the most to gain from virus containment. Meanwhile, laggards included sectors that performed well over the past 12 months, namely Data Centers, Towers, and Industrial Warehouses. The prospect of accelerating economic growth outweighed the effects of rising long-term interest rates leading to outperformance for REITs over broader equities as a whole.

Commodities

Commodities were up 6.9% as measured by the Bloomberg Commodity Index for the first quarter of 2021. The notable outperforming sector was Energy as the supply for oil was managed with cuts by OPEC members as well as the new administration in Washington suspending licenses to drill while it reviews domestic energy policy. Industrial metals, led by copper, also posted an increase in prices benefitting from expectations of rising industrial actively and global re-opening. A notable underperformer during the quarter was gold, which fell by over 9%, due to lower market volatility and higher interest rates.

Important Information: 

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This information is not meant as a guide to investing, or as a source of specific investment recommendations, and Wealth & Fiduciary Services (WFS) make no implied or express recommendations concerning the manner in which any client’s accounts should or would be handled, as appropriate investment decisions depend upon the client’s investment objectives. 

The information is general in nature and is not intended to be, and should not be construed as, legal or tax advice. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The information is subject to change and, although based upon information that WFS, considers reliable, is not guaranteed as to accuracy or completeness. WFS makes no warranties with regard to the information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, the information. The economic forecasts set forth in the presentation may not develop as predicted.