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Q1 Capital Market Highlights

As it has come to be expected from post-pandemic markets, equity markets posted strong returns in Q1, driven by encouraging signs on vaccine rollout (especially domestically), positive earnings releases, and fiscal stimulus. Increases to deficit spending coming from the $1.9 trillion budget reconciliation bill, along with proposals for infrastructure legislation and the potential for two more budget reconciliation bills this year (both of which are designed to increase fiscal deficits in the near term) allowed markets to more than shrug off proposals for an increase to the corporate tax rate, which was largely seen as within existing expectations. While much of that sounds like the same story we have been telling for the past year, Q1 market performance had significant volatility as markets digested two separate instances of large hedge fund blow-ups impacting broader markets, and inflation expectations drove interest rates higher.

As a result, while we can look back on the first quarter and see many encouraging signs, there is a clear fragility to the current market state. In late January and early February, we saw a social media trading frenzy cause mayhem with the short allocations of many large hedge funds—most notably Citron—that created enough forced selling to drive broader markets lower. The sharp rise in interest rates resulted in a bad quarter for bond investors and a strengthening US dollar. This rate increase also showed strong correlation with growth companies underperforming value—providing some real evidence to support many market participants’ belief that lower interest rates provided a systemic advantage for more growth-centric companies.

Q1 Macroeconomic Highlights

The labor market recovery spiked well above expectations to end the quarter with March job gains close to one million. Most of the gains came from the market segments hit hardest by the pandemic (service sector, hospitality, and leisure). This is an encouraging sign since a recovery in those segments is strongly linked to consumers returning to normal activities. As a result, many analysts have begun revising the estimates upward for GDP over the next several years. CPI and PCE data both show upticks in inflation for the quarter, particularly in January.

While a large portion of these gains are certainly a reflection of a return to normalcy after decreased demand depressed prices in 2020, the unprecedented level of stimulus and historically high levels of household savings is driving expectations for a surge in demand in the latter half of the year, which is driving increased inflation expectations and higher commodity prices.


2021 Outlook

While we still expect strong equity market performance in 2021, volatility should continue throughout the year. There are several large variables driving market performance, all with significant risks of underperforming current expectations. The vaccine rollout is obviously a huge variable driving markets, and while the rollout appears to be going smoothly in the US this year, the international rollout has not gone as successfully. The level of government intervention driving the current recovery comes with its own risks as missteps from governments or central banks have outsized downside risks. The spending plans proposed by the Biden administration envision a significantly expanded role for the federal government in the US economy, which need to be productive enough that they offset the expected drag from higher taxes and increase in government borrowing rates resulting from higher inflation. Central bankers are committed to maintaining current levels of monetary support until they see inflation stabilize above their long-term target, but there are significant concerns that they could lose control over the long-end of the interest rate curve and be forced to move earlier. Despite those risks, the tailwinds for the markets and broader economy lead us to expect equity markets to end 2021 with strong returns. As historic levels of household savings are injected into the economy once the vaccine rollout allows a return to normalcy, we should see consumer spending driving the economy well through the end of 2021 and into subsequent years.

Portfolio Update

The trifecta of increasing vaccination rates, fiscal stimulus, and easing restrictions in the US and across the world should continue to help unleash pent up demand. The improving economic backdrop is supportive of risk assets. We remain “risk on.” Current allocations are evenly weighted in growth and value with recent increases to US and international small cap companies. Due to our mid and long-term view on the devaluing of the US dollar, we remain evenly weighted on allocations to US versus developed international and emerging market stocks. iShares Dividend Growth ETF and Nuveen’s Small Cap ETF were key contributors to portfolio growth in Q1, while ARK Innovation and SPDR Gold ETF detracted from performance as these sectors were out of favor. Going forward, we anticipate rising rates and a difficult environment for traditional fixed income, so we shortened the duration on defensive strategies by adding managers from PIMCO, Reams, Eaton Vance and Western Asset who have a more flexible investment mandate. We also added an active manager in Baron Real Estate. This fund has an impressive team and investment philosophy with current allocations to data centers, e-commerce related warehouses and US based developers. It is anything but your traditional REIT or commercial real estate exposure. We added Vanguard US Value Factor ETF in models to increase passive exposure to previously out-of-favor sectors like industrials, consumer discretionary, and financials. Structured notes performed in line with expectations compared to the MSCI All Country World Index and continue to a be a key contributor to managing drawdown risk.

We are grateful for your continued trust and confidence.  We wish you and your family a safe Spring.