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Investment Insights - Quarter 1 Review

April 01, 2021
By Patrick V. Masso, CFA

The first quarter is in the books and largely played out as expected, with a few unexpected hiccups along the way.

GDP growth and inflation metrics accelerated as forecast and should continue to do so through the first half of the year. Stock markets have been led by cyclically-sensitive sectors (energy, financials, industrials, materials) and the bond markets have sniffed out imminent inflation risks.

Lapping several low points that punctuated 2020 create straightforward “base effects” used in calculating the year-over-year cadence of economies. Think about a business comparing its sales in March and April 2020, when it may have been shut down, to sales in March and April 2021. This effect is expected to wane in the back half of the year.

Volatility typically falls during improving macroeconomic periods like the present. However, there have been three distinct spikes during 2021, making for choppier than anticipated conditions. Luckily, and as suspected, each of these spikes have been episodic and non-trending – unlike the continuous surge in volatility that happened last year.

The first volatility event occurred just a few days into the year when the Capitol was ransacked. This momentarily capped sentiment and risk-taking desires before fading away.

The second spike in volatility came just a few weeks later when multiple leveraged hedge funds were caught on the wrong side of trades. News stories of GameStop and AMC Entertainment quickly hit mainstream news outlets touting the “little guy” getting the better of those generally regarded as more sophisticated investors. Despite some short-term carnage, this event, too, receded into the history books.

Another shot across the bow came in the form of rapid increases in long-term interest rates, with the 10yr US Treasury Yield moving north of 1.60%. Long duration interest rates tend to rise when the outlook firms up. Nothing new there. It was the breakneck pace at which this happened that sent a mild shockwave through many asset classes.

Despite these three distinct events, risk assets performed relatively well compared to safer bets. Aggregate bond prices came under pressure and showed losses for the quarter. Again, this is not terribly surprising given the rosy macroeconomic backdrop.

Moving forward, the labor market continues to heal more quickly than initially anticipated. In fact, the March labor market report showed a surge of new jobs created – 916,000! The unemployment rate stands at 6%, less than half of what it was at the pandemic peak.

Be on the lookout for details surrounding the Biden administration’s infrastructure spending bill. Preliminary details have been released and the size and scope of spending should not be understated. It appears a significant portion of this plan will be financed by tax increases on corporations and wealthier individuals and families. As we inch closer to 2022, markets are likely to begin discounting the impact on corporate earnings.

The Fed remains in a difficult spot. Economies are clearly starting to heal, but still have longer to recoup what was lost. Communications from the Fed show a desire to keep short-term interest rates anchored at very low levels through the end of 2023. Expect to hear the words “transient” and “transitory” used to describe inflation dynamics in the coming months.

The leadership from cyclically-sensitive areas of markets should continue in Q2. Risks remain on the horizon, particularly as comparisons become more challenging in Q3 and Q4. We remain vigilant and ready to act as underlying dynamics shift.

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