- Optimism is increasing throughout the world and the investment markets.
- Stocks continue to do well, with US stocks still outpacing broad international benchmarks.
- Rising interest rates spark discussions about inflation.
A Strong, Optimistic Start for the US
The year is still young, but 2021 is certainly off to a better start than 2020 with promising signs of further progress and recovery from Covid-19. People are receiving vaccines at an increasing pace, with the United States recently exceeding 4 million doses administered in one day. Such numbers are giving rise to stronger optimism among people, business owners, and investors alike. It’s hard to say when “normal” will return, but we’re making progress toward that goal every day.
The economy and the stock market are moving in unison this year, unlike last year’s strong divide where stocks soared when the economy slumped. As we’ve discussed several times, the stock market tends to be forward looking. To that end, we’re encouraged to see stocks continuing on a strong path to start the year. We also recognize that the stride of stock gains might not remain as strong as the stride of economic recovery as the year progresses. The economy has some catching up to do, but many key economic indicators are trending in a positive direction.
The one hard-hit area of the markets in 2021 thus far is bonds. Bonds are feeling pressure as interest rates are climbing up from record lows. This is something of focus in our quarterly discussion below, both in relation to bond investments and the outlook for inflation.
Growth Prospects Are Looking Strong
Our US economy is growing at one of the fastest rates in recent history. Not every segment of the market has yet to recover, but growth is abounding. Our US GDP growth is expected to reach 6% or higher this year. Jobs are coming back at a fast pace with over 900,000 jobs created in the month of March alone. The unemployment rate has already declined from 14.7% to 6% in eleven months, and it could reach 4% (considered the normal unemployment rate) by year-end.
There are many factors contributing to growth including pent-up demand, significant government stimulus, a massive housing boom, low interest rates, increasing business and consumer optimism, and more. What’s important to note is that the economy is beginning to thrive, even while people are still restrained in activities. Virtually everyone has a wish list of things they want and plan to do once they feel safer about indoor activities, traveling, gathering, etc. Hence, the potential for additional economic growth after such an extended pause in normal activities could be significant.
Nothing is ever guaranteed (particularly as the pandemic continues), but short-term growth prospects are certainly encouraging.
Broader Market Participation
Looking specifically to stocks, another very encouraging sign that emerged from the first quarter is broader stock market participation in the recovery. Technology and many other growth-oriented stocks soared in 2020, while a large majority of higher dividend paying “value” stocks lagged last year. A rotation occurred in the first quarter with value stocks significantly outperforming growth stocks. We don’t know if this shift will persist, but it is encouraging to see companies in battered segments of the market gain traction in the recovery.
We always maintain exposure to both growth and value-oriented investments as part of everyone’s investment mix.
A Jump in Interest Rates
Economic growth isn’t the only big move to report. Interest rates also experienced a significant move in the first quarter. The 10-year Treasury yield is a key benchmark that influences broader interest rates. Last year, the 10-year Treasury yield fell to historic lows, dropping close to 0.5%. Yields rose in the later part of 2020, but a dramatic increase occurred in the first quarter of 2021. The 10-year Treasury yield began the year just above 0.9% and ended the first quarter at 1.746%, representing more than a 90% increase in three short months.
Interest rates are important for a variety of reasons. They impact stock prices, bond prices, real estate values, borrowing costs, inflation and more. Generally, higher interest rates tend to stunt growth as the costs of borrowing and financing increase. That said, we’re in an interesting time of facing rising interest rates from ultra-low levels, levels that were so low that they were disconcerting. We also just witnessed one of the most dramatic economic recoveries in history. Everything was exacerbated over the past year. Hence, while rates could go higher, we think there’s potential for the pace of any further rate increases to be more modest going forward. Furthermore, the Federal Reserve Board (Fed) has reiterated intentions to keep interest rates low and its balance sheet steady. This means that there’s no push by the Fed to push interest rates higher, and that the Fed still stands by an accommodative rate structure.
Bonds Impacted by Rate Increases
Bond investments were negatively impacted by rising interest rates in the first quarter. Bond yields and bond prices move inverse to one another, meaning that bond prices decline when yields rise. The Barclays Aggregate US Bond Index was down 3.37% during the first quarter.
Many of our clients hold exposure to bonds as part of their portfolios for income, capital preservation and overall portfolio risk mitigation. We caution investors that if interest rates continue to rise there is potential for bonds to experience further declines.
However, we believe it’s important to put bond market declines in context. The US bond index was down a little over three precent in three months after a stunning move in rates, but stocks and other asset classes can easily waver by this percentage amount (or more) in a single day. History shows that while bonds can fall under pressure when rates rise, the losses they’ve suffered (even in extreme periods) pale in comparison to the losses that stocks and other assets can experience. Hence, we strongly discourage shifting out of bonds if they are appropriate for income, capital preservation, risk reduction and “sleep-well-at-night” considerations.
Is Inflation Coming?
A common reason for rising interest rates is the expectation of inflation on the horizon. The potential for increased inflation is certainly possible due to pent-up economic demand, a recovering global economy and massive government spending. While there’s no current evidence to suggest we’re moving into a high inflationary period, we will speak to investment means to combat inflation. Treasury Inflation Protected Securities (TIPS) and gold are commonly considered options. While they could do well, they are not guaranteed to combat rising interest rates. This has been proven thus far in 2021. As interest rates spiked in the first quarter, TIPS were down almost 1.7% and gold was down close to 10%.
In our opinion, stock investments are often the best means to combat inflation as the pace of stock gains over history far outweighs long-term historical inflation rates.
We’re generally optimistic as we look forward in 2021, while recognizing that nothing is ever a guarantee in investment markets. We strongly advise investors to maintain a long-term investment outlook that carefully considers growth needs and goals relative to key risk considerations. Furthermore, we remain committed to our disciplined long-term investment approach which has proven successful as opposed to market timing.
As always, we invite you to contact us to discuss any considerations relevant to your investments and personal finances.
SageVest Wealth Management