- Fiscal stimulus and vaccine rollout have far exceeded expectations at the start of 2021
- Equities overcame bouts of volatility, and the Dow and SPX surged to new highs
- 10YR UST rates surged 83bps in Q1 for its largest net gain since Q4’16
- Value outperformed Growth by ten percentage points in Q1, largest in 20 years
- Commodities were modestly lower as the greenback rose for its 3rd consecutive month
- S&P 500 corporate earnings are forecasted to grow 23% in Q1
Despite a bout of volatility that surfaced in the back end of the quarter, U.S. equity markets surged higher in Q1 2021 on the back of two overriding themes – greater than expected stimulus and vaccine progress. The stimulus at the end of 2020 ($900B) and the relief package signed in early March ($1.9T) equate to nearly 14% of US GDP. The American Jobs Plan announced on the last day in March proposes an additional $2.25 trillion in spending geared largely toward improving transportation, communication, and power infrastructure. The infrastructure plan will 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.
The largest vaccine rollout in history is underway, and already more than 590M doses have been administered worldwide. Bloomberg estimates more than 150M doses have already been given in the U.S., which exceeds the total number of positive cases since the start of the pandemic. In the last week alone, an average of 2.8M doses was administered each day, and the administration hopes to have enough supplies available to all adults in the U.S. by the end of May. While global cases are on the rise, including a recent uptick in the U.S., the average rate of inoculation is vastly outpacing the rise in new cases.
Federal Reserve Chairman Jerome Powell provided an economic update to the House Committee on Financial Services and again reaffirmed the central bank’s commitment to support the recovery. Powell expressed limited concern to the recent volatility in the capital markets due to the well-capitalized banking system and reiterated the Fed’s stance on monetary stimulus. He made clear substantial progress will be required before any changes are made to the asset purchase program, while noting the FOMC will pull back support very gradually, and with great transparency, when the economy has all but fully recovered. He also sees the sharp rise in rates as an “orderly Process” and a sign of economic confidence.
Amidst a backdrop of heightened volatility, the Dow (+6.8%) and S&P 500 (+4.7%) closed out their best month since November, with each benchmark reaching new highs in the final week. The Nasdaq 100 lagged with a modest gain of 0.5% as growth stocks were pressured by the sharp rise in rates. The Russell 1000 Value Index (+5.7%) outperformed the Russell 1000 Growth Index (+4.7%) by four percentage points, after outperforming by six percentage points in February. February’s outperformance was the largest since March 2001.
Q1 continued the trend, which began in October with a rotation from Growth to Value and large-cap to small-cap. For the quarter, the Russell Microcap (+23.9%), S&P Midcap 400 (+13.5%), and Russell 2000 (+12.7%) were the top performers. The Russell 1000 Value Index (+10.7%) outperformed the Russell 1000 Growth Index (+0.7%) by 9.9 percentage points, its largest outperformance in 20 years.
The below relative strength chart plots the weekly ratio of Value versus Growth (blue line) and its 40-week simple moving average (SMA). The 40-week SMA (violet line) is a favored metric for longer timeframes, given it is synonymous with the widely followed 200-day SMA. In March, the spread of the ratio to the 40-week SMA rose to more than 10%, which has not happened since the early 2000’s when Value started a multi-year trend of outperformance.
At the sector level, the defensive Utilities (+10.5) and Staples (+8.2) rebounded sharply bring both groups into positive territory for the year. REITs (+6.4%) had their best month since November and have strung together five consecutive months in the green. The cyclicals remained strong, led by Industrials (+8.9%), Materials (7.6%), and Financials (+15.9%). Energy (+2.8%) slowed its torrid pace with a relatively modest gain. For the quarter Energy (+30.8%) and Financials (+5.8%) are the only two sectors in double-digit territory.
Rates, Commodities, and the Dollar:
Long rates exploded higher throughout Q1, with the UST 10YR Yield rising 15bps (Jan), 34bps (Feb), and 34bps (March). The 83bps rise in Q1 was the largest quarterly gain since Q4 2016 (85bps) and Q2 2009 (87bps). Accordingly, the yield curve steepened meaningfully with the 10YR-2YR UST spread widening by 79bs in Q1. While this is the highest rise since Q1 2008, which nearly marked the onset of the Great Recession, the prior highs occurred in the early 1980’s in the early stages of a historic bull market.
The below chart of the UST 10YR yield (monthly period) shows the long rate easily knifing through expected long-term resistance in the 1.32% - 1.43% range (arrows), which previously represented major lows from 2012, 2016, and 2019. Many eyes are looking towards 2% as the next stop; however, longer-term, the ~3% level appears more significant from a technical perspective.
The US Dollar Index (DXY) rose for the third consecutive month for a gain of 2.6% in March. Similar to long rates, this was its best monthly performance since November 2016. The recent January low bottomed near the lows from 2018, yet the 12-month trend of lower highs is still in place. Price did recently move back above the 40-week SMA, so it is on watch to see what it can do from here.
The strength in the dollar proved to be a headwind for commodities. The Bloomberg Commodity Index (BCOM) declined 2.2% following a streak of five consecutive months in the green and gains in nine of the prior ten months. WTI crude declined 3.8% and copper dropped 2.4%. Precious metals remain soft, with gold falling 1.5%, registering declines in seven of the prior eight months.
Earnings season is soon upon us, and expectations are high. According to FactSet, the estimated Q1 EPS growth rate for S&P 500 companies is 23.3%, which is up from the 15.8% growth forecast expected at the start of the quarter. The previous high was in Q3’18 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 forecasts of 3.9% 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% GDP) and stronger vaccine rollout (30% of U.S. population) are larger and faster than what most expected just three months earlier 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 (7%) 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 should continue to support equity markets.
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