The economy continues to improve from the nadir of the pandemic. The Conference Board’s monthly Leading Economic Index (LEI), composed of 10 economic components whose changes tend to precede changes in the overall economy, continues to improve.
Employment figures also continue to recover from the shock of the pandemic. The U-3 unemployment rate has continued to drop, albeit still not at pre-pandemic levels.
The Conference Board’s Employment Trends Index (ETI), which aggregates eight leading indicators of employment, continues to trend higher, suggesting further gains ahead for employment.
The U.S. Treasury yield curve continues to steepen, indicating expectations for further economic growth. Instead of observing just one yield curve spread (e.g. the 10-year Treasury yield less 2-year Treasury yield), we like to view an aggregate of varying spreads to see the overall behavior of the yield curve. Currently, no spreads are inverted and the average rate of the curve spreads is positive, both of these observations being positives for the economic outlook.
Broad market indices posted strong performance during the first quarter of 2021.
Observing the returns for various investment factors – Growth, Momentum, Value, Quality and Low Volatility – in the chart below, the pendulum swing from large-cap growth and momentum stocks to small-cap value stocks that began last year during the market’s recovery from the pandemic, continued to strengthen in Q1 2021.
Historically, small-cap value and large-cap growth/momentum stocks tend to be the most negatively correlated factors, creating an interesting dynamic and a potential opportunity to earn better returns depending on which factor is outperforming. The chart below, based on trailing 12-month returns, shows the number of months in a row that either small-cap value is outperforming large-cap momentum (positive numbers) or vice-versa, the months in a row where large-cap momentum is outperforming small-cap value (negative numbers). The last decade has primarily been dominated by large-cap momentum stocks outperforming small-cap value, but as the trend began to switch during 2020, small value has taken the lead.
As discussed in our prior post Pain in the Bond Markets, the bond market experienced a painful first quarter. In 44 years of the flagship index, the Bloomberg Barclays U.S. Aggregate Bond Index, this was the second worst start to a year ever recorded. The silver lining based on historical precedence is that forward returns tend to be positive. Not including 2021, 12 calendar years posted a negative performance in the first quarter of the year, of which 9 (75%) went on to finish with a positive return for the year.
The chart below shows the return of various bond asset classes. Note that they are ranked from least-to-most correlated to the stock market (S&P 500 Index). This is useful as most investors view bonds as a ballast to their stock allocation, providing protection during bouts of stock market volatility. What stands out below is that those bond asset classes (e.g., treasuries, investment grade corporates) that are least correlated with the market suffered more during the first quarter of 2021, while those bonds most correlated with the market (high yield, convertible bonds) held up better.
The first quarter was positive for stock investors, albeit the bond portion of their allocation was left wanting. Bonds should begin to potentially recover if history is a useful precedent, and stocks should remain constructive given the economic backdrop. That said, the year started relatively tame in terms of volatility, so we could expect to see some bumps along the road as the year progresses. Readers should be aware that since 1980, the average intra-year decline of the stock market (S&P 500 Index) has been a decline of about -14%. The chart below shows the intra-year declines and annual returns for the S&P 500 Index from 2000 through the first quarter of 2021.
Maintaining a long-term perspective through these bouts of volatility is helpful.