In our last quarterly blog, we noted that, “the single most important driver to a successful new year with positive economic growth and growing corporate earnings is the timing and speed in which governments can overcome and resolve the Covid-19 pandemic”. While statistics and events are still preliminary and developing, so far, the vaccine rollout has been effective and encouraging, particularly in the US. While Covid-19 surge areas still exist, much of the US and some of the global world has seen dramatic improvements with lower
cases, deaths, and hospitalizations. This has allowed economies to reopen on a gradual basis and has led to increased demand for consumer spending.
As the markets foresaw the potential for relief from the pandemic and the reality set in that economies would open again, stocks emerged from the Covid meltdown with a historic 12-month run. On March 23, 2020 the US stock market hit bottom as fear and shock gripped investors as the pandemic gained strength. Exactly 12 months later, stocks had completely reversed course and were at near all-time highs. More specifically, since their lows in 2020, all three major US indices have soared, with the Dow Jones, S&P 500, and Nasdaq gaining 76%, 76%, and 95% respectively. This represents one of the best 365-day stretches for these indices since World War II.
Starting the second quarter of 2021, the economy appears to be poised to build on its recovery progress bringing with it a greater economic re-awakening. We believe there is significant pent-up consumer demand, some of it stemming from an accumulation of more than $1.4 trillion in excess savings during 2020, due to lower spending and income gains from fiscal stimulus. As such, evidence seems to show that the US economy is approaching the mid-cycle business expansion phase. Furthermore, as the recent $1.9 trillion fiscal stimulus package makes its way to the American people, vaccines continue to roll out and be implemented, and the government continues its monetary policy support, we expect to see further expansion of the economy and a favorable environment for equities.
It is important to note that riding an expansion recovery can be a tricky balancing act which can lead to increased market volatility and short-term corrections in the near term. Several factors will be imperative to monitor. Leading the list is the potential of rising rates and inflation. The recent bond selloff in February grew worries of more to come as the economy really starts to gain traction. While this is a valid concern, it is a normal part of a recovery and if gradual, will be part of a renormalization of rates. This should lead to a rotation from long-duration assets, such as big-cap growth stocks, into more cyclical, value, and small-cap equities. If on the other hand, the rise in interest rates is more rapid, it could undermine support for equity valuations. Inflation fears have also resurfaced as central banks and governments have aggressively stimulated their economies to combat the effects of Covid-19 and the resultant economic shutdowns. While inflation rates have jumped from mid-shutdown lows and are now generally above pre-pandemic levels, the Federal Reserve is determined to keep rates low until we get back to full employment.
As we shift towards a global economic expansion, we will be looking to add value oriented and cyclical stocks to our asset allocation. These economically sensitive sectors tend to outperform as activity improves. Additionally, we added to our international holdings because these markets will benefit as global economies reopen and as domestic headwinds of potential rising US interest rates, inflation, and the possibility of higher US corporate taxes begin to surface.
An increase in market speculation and momentum trading has pushed equity valuations to historically high levels. This stretched pricing does give us some concern as to where the markets are heading near term, so close attention to inflation and interest rates is important for evaluating new security purchases. As a valuable tool for hedging positions, generating income, and obtaining lower entry pricing, we will continue to utilize our call and put stock option strategies.
We continue to pray that you and your family stay healthy and safe.