US Economy: Fits and starts.
Retail sales (-3% in Feb.) and other consumption data disappointed, whereas production data improved, including manufacturing activity (60.8 ISM Index). While headline unemployment is down to around 6%, the broader U-6 measure that includes underemployed and discouraged workers was just under 11% at the end of March.
US Stocks: Value overtakes growth.
Equities were again broadly positive in March to the extent that large-cap and small-cap stocks have returned more than 56% and 94%, respectively, in the past 12 months. So far in 2021, amid rising interest rates and expectations for cyclical reopening, value-oriented sectors have distinctly outpaced their growth counterparts.
Foreign Stocks: China loses steam.
Investors looked past the Eurozone’s rising Covid cases and vaccine distribution struggles to drive European stocks higher on monetary stimulus and strong manufacturing activity. Conversely, largely post-Covid China (-6.3%) drove emerging market stocks down on lofty valuations and expectations for monetary policy normalization.
Fixed Income: Rates rise again.
10-year US Treasury yields rose to 1.7%, about where they were at the start of 2020. While the Fed has downplayed inflation risks, investors are not convinced, bidding up TIPS and high-yield debt. Munis have also been insulated, with investors encouraged by the $350 billion received by state/local governments in the latest fiscal stimulus.
Real Assets: Commodities settle down.
Commodities fell this month, with major components gold (-2%) and oil (-4%) each in negative territory. Meanwhile, REITs and infrastructure equities posted returns competitive with the broader stock markets, with both categories sought after for income and relatively attractive valuations.
Alternatives: Middle of the pack.
Liquid alternative strategies posted middling returns relative to other asset classes but have soundly outperformed core fixed-income so far in 2021 and over the last 12 months, providing the uncorrelated returns they are known for. Not surprisingly, long-biased equity managers and fundamental value strategies were the best performers.
Equities Total Return
|U.S. Large Cap||4.4%||6.2%||56.3%|
|U.S. Small Cap||1.0%||12.7%||94.8%|
Fixed Income Total Return
|U.S. Agg. Bond||(1.2%)||(3.4%)||0.7%|
|U.S. High Yield||0.2%||0.9%||23.3%|
|Munis Broad Mkt||0.6%||(0.4%)||5.6%|
Non-Traditional Assets Total Return
|Overall HF Market||(0.1%)||1.2%||16.1%|
|Gold Spot $/OZ||$1708||$1886||$1577|
|U.S. Dollar Index||114.1||117.3||122.7|
Nothing has changed to dissuade us of our view that the global and US economies will continue to repair from Covid in 2021. The US vaccination rate is accelerating almost daily; many states have begun allowing broader access and are aiming to offer vaccines to everyone by May. While retail sales and some other consumer data have cooled off, winter weather and temporary supply chain disruptions are at least partly to blame. On balance, the economic data continues to point to a bounce-back year for the economy. Another $1.9 trillion in fiscal stimulus signed into law in March would appear to solidify that outcome.
In the financial markets, talk of inflation and the rapid rise in interest rates continue to be the dominant stories. Although higher inflation might seem inevitable given the massive increase in the money supply, it’s worth noting that inflation did not surge when similar measures were taken in scope, if not in scale, after the Great Financial Crisis. The Fed believes rapid inflation will be transitory as significant slack in the labor market will help prevent sustained acceleration. Longer term, ongoing technological innovation is likely to keep inflationary pressures in check as well.
The Fed has underscored they will keep their target interest rate near zero for years, even if inflation accelerates. Investors seem skeptical as evidenced by the rise in Treasury yields. The sheer volume of Treasury bond issuance required to raise $5.5 trillion in cumulative Covid relief plus the Biden administration’s proposed $2 trillion infrastructure plan suggest that interest rates are likely to climb higher. However, three key developments could keep US interest rates in the range they have been in during most of the past decade: demand for fixed income from aging populations globally; lower rates abroad (making US bonds relatively attractive); and the Fed’s theoretically limitless ability to keep buying fixed-income assets.
What We’re Doing
We are adhering to our long-term asset allocation targets with some tactical adjustments on the margins. In terms of shorter-term positioning, we continue to recommend maintaining elevated equity holdings at the expense of fixed income, with an eye on cyclical sectors that are more sensitive to economic reopening. Thus far, these areas have outperformed on a relative basis, as we thought they would in 2021. Assuming interest rates continue to climb higher from here, at some point core fixed income will become more attractive on a risk-adjusted basis, fulfilling its primary role as portfolio diversifier. But we don’t believe we’ve reached that point yet. Lastly, we are reviewing our allocation to real assets to make sure we have the right combination of exposures should inflation accelerate more quickly and on a more prolonged basis than we anticipate.