Major stock indexes advanced by 2% on the week and continued a great start for the second quarter of 2021. Before we go forward, we will look back at performance during the first quarter, then dive into the latest economic indicators. Economic activity is gaining traction due to expanding vaccine distribution, fewer public health restrictions, and substantial fiscal support. The economic risks are tilted to the upside. Inflation may return, but should not run wild.
Believe it or not, the first quarter of 2021 is in the books. Let’s take a look at how markets and leading economic indicators are performing, emerging trends, and other important factors that we are monitoring.
In the table below, we have updated an asset class performance matrix highlighting the returns of various investable indexes, sectors, styles, and asset classes over the trailing 1 year, first quarter of 2021, and year-to-date, as of Friday’s close.
The major stock indexes had a good first quarter and are off to a great start in April. Solid market gains do not tell the full story of rapidly changing market conditions. While interest rates are still low by historical standards, the yield on the 10-year US Treasury note jumped by 89% to 1.74% by quarter-end amid concerns of an inflationary outbreak fueled by massive fiscal stimulus and pent-up consumer demand.
Value stocks, which are widely seen as the biggest beneficiaries of a stronger economic recovery, outperformed growth stocks by a wide margin, continuing a rotation that began last November. Yet the equity style rotation has not been linear, with investors pivoting daily between growth and value stocks. That indecision continues again in April with the NASDAQ leading all major stock indexes month-to-date after being the laggard in the first quarter.
The move in interest rates has had a direct impact on the bond market. The only positive sector year-to-date is high yield corporate bonds, which are traditionally more correlated to equities. The most interest-rate sensitive sector of the group – long-term US Treasury bonds – are down more than 10% year-to-date. For perspective, the 13%+ decline in the first quarter was the worst quarter for long-term Treasuries, as measured by the BofA/Merrill Lynch 10+ Year Treasury Index, in 41 years.
Just this week, the International Monetary Fund (IMF) increased their 2021 global growth forecast from 5.5% to 6%, including a 6.4% growth projection for the U.S. economy. Last month, Goldman Sachs raised their annual U.S. gross domestic product (GDP) forecast to an 8% growth rate to reflect the latest fiscal policy and vaccine rollout expectations. It is one of the more bullish views on Wall Street, but an 8% economic growth rate with inflation expectations of just 2.1% would be almost unprecedented. U.S. GDP has not grown 8% in a calendar year since 1951 when the total size of the economy was only $356 billion. U.S. GDP growth of 8% this year would put the size of the economy at approximately $22.6 trillion, marking a full recovery from the COVID-19 recession of 2020.
More importantly, economic data continues to back up projections that U.S. growth is set to surge. On March 30th, the Conference Board’s Consumer Confidence Index, a leading indicator that has remained mired near its COVID lows, surged by 19.3 points in its third-largest monthly increase in the survey’s history. Relative to expectations, the March Consumer Confidence report was the strongest since at least 2000. Lynn Franco, Senior Director of Economic Indicators at The Conference Board, “Consumers’ assessment of current conditions and their short-term outlook improved significantly, an indication that economic growth is likely to strengthen further in the coming months. Consumers’ renewed optimism boosted their purchasing intentions for homes, autos, and several big-ticket items.”
Confidence surveys may be considered “soft” data, but you can see it bearing out in the actual high-frequency data. Consumer credit & debit card transactions are now 14% higher than pre-COVID levels, hotel occupancy is only 17% lower, restaurant diners are 18% lower, and airline traffic is 38% lower. The recent trendline on the last three indicators is steeply positive after flatlining for most of 2020.
The March jobs report was much stronger than expected and suggests an even more powerful recovery than implied by the Fed’s recent projections. Jobs increased by 916,000 in March, well ahead of a consensus expectation of +658,000. Revisions to January and February data added another 156,000 job gains. Using the March jobs report data, the U.S. has now recovered 14 million, or 62%, of the 22.4 million jobs lost during the coronavirus pandemic. The unemployment rate fell to 6.0% from 6.2%, in line with consensus expectations, and the labor force participation increased by 347,000 in March, showing a continued decline in the pandemic’s effects on the labor market.
Late last year, we labeled inflation as the critical factor to watch in 2021 due to its impact on Federal Reserve policy and interest rates. Inflation has continued to run below the Fed’s 2% target. February’s year-over-year core Personal Consumption Expenditures (PCE) index decelerated to 1.4% (1.5% prior).
However, higher commodities prices, trade bottlenecks, and projections for the fastest rate of economic growth in 60 years have led to fears of overheating. These inflation fears are likely to grow over the next several months as economic activity normalizes, and prices normalize along with it. The headline Consumer Price Index (CPI) inflation may likely increase to 3.5% year-over-year in May, which would be the fastest pace in 10 years, while core PCE is expected to reach 2.3%, which would be the fastest pace in 13 years. However, it would be premature to read too much into these inflationary readings. Over the next several months, we will likely witness a multi-month price level adjustment, which may feel like a shift higher in inflation. However, over the second half of 2021, as the economy further normalizes, subsequent growth in economic activity and prices will likely moderate and bring the inflation rate back down to trend. The 5-year, 5-year forward inflation expectations look no different than the previous decade.
Have a great Sunday!
Timothy W. Ellis, Jr., CPA/PFS, CFP®
Senior Investment Strategist, Wealth Strategist