Market Recap

Quarter 1:



The last worldwide pandemic we had began in 1918 and lasted until 1919. What happened after this pandemic? That’s right, the “Roaring 20s!” There is a lot of pent up demand that is not being actualized due to COVID. What do you think happens once the vaccine is fully rolled out?

Jeff Powell | CIO, Managing Partner Tweet
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The first quarter of 2021 was another strong quarter for the S&P 500, posting a 6.17% total return in the midst of our continuing worldwide coronavirus pandemic. This marks three straight quarters of strong performance in the broad-based markets, as the world economy has begun to recover from the COVID-19 outbreak.

Q1 2021 S&P 500 Price Movement

The first quarter of 2021’s market strength was a continuation of how we saw 2020 end, with “value” stocks significantly outperforming “growth” stocks. This was something that Polaris Wealth predicted, writing about it extensively and calling it out in our 2021 Market Outlook webinar in January. As you can see from the illustration below, large-cap value was up 11.3% during the quarter versus only a 0.9% return in large-cap growth.

Performance by Investment Style and Market Capitalization

As you can see in the chart to the above, large-cap value outperformed large-cap growth at levels we haven’t seen since the dot-com bubble burst in the early 2000s. Historically, value has outperformed growth approximately 60% of the time, while taking less risk in the process. Again, the adjacent chart above illustrates that we’ve been in a growth market for several years. Many market pundits, including those of us here at Polaris Wealth, believe that we are moving into a time period where value will outperform growth most quarters, for several years to come.

Russell 1000 Growth minus Russell 1000 Value
Quarterly Percentage Change (2021-03-31 = -9.92)

Asset Class Benchmark Performance

Many economists are concerned that the United States might enter a period of inflation. Their fears are not unwarranted, with trillions of dollars in stimulus packages (and discussions of more) and the Federal Reserve holding rates at zero percent for the foreseeable future. Interestingly, we saw commodity prices surge during the first quarter of 2021, which can be an indication of inflation.
But we also saw the dollar increase in price and gold drop by almost 10% during the same period. This is the exact opposite of what you’d expect if we were experiencing inflation. As you can see from the chart below, the U.S. Consumer Price Index inflation rate is very low from a historical perspective at 2.6%.

U.S. Consumer Price Index – February 1914 to February 2021

The top three performing sectors in the S&P 500 were Energy, Financials, and Industrials. None of the eleven sectors had negative performance, but consumer staples, information technology, and utilities had the worst performance for the quarter, with 1.1%, 2.0%, and 2.8% respectively.
The global recovery has been felt by most countries during the first quarter. Approximately three-quarters of the forty-five countries that make up the All-Country World Index had a positive performance in their own currency.

Global Market Performance Ranking

While the first quarter of 2021 was a strong quarter for stocks, it wasn’t all good for the bond market. In fact, it was one of the worst quarters on record, going back over 100 years. As you can see from the chart on the right, the 30-year treasury had its worst quarter since Q1 1980, down 13.5% in just three months. 

Shorter duration bonds weren’t down nearly as much, but the U.S. Aggregate Bond Index was down 3.6%, while U.S. corporate bonds were down 4.6%.

U.S. 30-Year Treasury Quarterly Returns 1/1/1927 - 3/31/2021

As we’ve discussed extensively in our Polaris Perspective educational articles for years, we are in the middle of a secular bull market. As we’ve discussed, the average secular bull market lasts 14 years. We began our secular bull market in 2013, which means that our markets should continue to trend up for at least another six years if we are dealing with “average.” Keep in mind, there are bear cycles inside of secular bull markets. That’s what we experienced with the correction in 2018 and the coronavirus pandemic in 2020. Just like in the 1982 thru 2000 secular bull market, an investor still went through the 1987 crash, the 1990 recession, and 1994. Had you just stayed fully invested during this 18-year secular bull market, not allowed yourself to be shaken out, and matched the S&P 500’s performance, your million dollar portfolio would have grown to well over $20 million.

S&P Composite Index –
Log scale, annual

This is why we are so adamant about getting clients off the sidelines and getting their money working for them. You must “make hay while the sun shines.” And you must ignore the static knowing that “bull markets climb a wall of worry.” If this is indeed an average secular bull market, then we are just past the midway point. What if it’s a longer than average secular bull market? Do you want to be invested and take advantage of the rest of this secular bull market, or do you want to allow yourself to get frightened out of the market by the media, a newsletter, a friend that knows more about the markets than you, a gut feeling… ?

The Rest of 2021

So, what’s in store for the rest of the year? The advice is really not any different than the advice given three or six months ago. But let me reiterate some of what we’ve been talking about for months.

It’s All About COVID

It’s pretty straightforward. COVID-19 shut down the world’s economy. Getting vaccines in arms and getting herd immunity is the path back to life as we knew it prior to our worldwide pandemic. It’s why we track daily new cases, not only in the U.S. but throughout the world.

COVID-19 - U.S. Daily New Cases
Cases per day, data as of 0:00 GMT+0

As we all know, when the number of cases rises, it taxes the medical systems in the cities, states, regions, or countries. The unfortunate result is a higher death rate. While we are seeing a dramatic drop off of daily new cases and death rate in the United States, unfortunately, the worldwide numbers for daily new cases and death rates are on the rise, something we are monitoring closely.

COVID-19 - U.S. Daily Deaths
Deaths per day, data as of 0:00 GMT+8

People with at Least One Dose
of COVID-19 Vaccine

In order to create a herd immunity, COVID-19 must be abated not only in the United States, but throughout the world. Otherwise, we will have to fear that the virus is mutating. Many countries have adapted their own standards of distributing the vaccines available to them. Many countries are opting to get at least one shot into as many people as possible, knowing that the Pfizer and Moderna vaccines are 80% effective with just one dose. Instead of waiting three weeks for the second dose, as is done in the United States, many countries are waiting twelve weeks for the second dose.
Herd immunity in the United States will come as a result of some of our population getting COVID and the other part being vaccinated. When more than 70% of the population has antibodies in their system, we should see a dramatic drop off in the number of new cases, hospitalization rates should plummet, and our death rate should go down to levels not seen since the pandemic began.

The Path to Herd Immunity -
Total Immunity Estimates

Whether you theoretically believe in government stimulus or not, it’s here. Stimulus, if appropriated properly, can turn into significant growth. We have received many questions from clients worried about the impact this stimulus will have on inflation and/or the value of the dollar. Stimulus doesn’t have to lead to inflation or devaluation of our currency. All we have to do is look at history. Let’s look at what happened to the U.S. economy under the Reagan administration. President Reagan lowered taxes and increased government spending, leading to one of the strongest economic growth periods in U.S. history.

S&P 500 Earnings per Share
Index annual operating earnings

We expect that the stimulus will drive corporate earnings in 2021 to levels above pre-pandemic levels, and we believe that as the U.S. economy fully opens up, pent up demand will continue this growth in earnings to higher levels in 2022.

The opening of our economy is completely reliant on vaccinations and suppressing COVID-19. There are several high-frequency economic activities that give us an understanding of if things are improving or stagnating. Most of them are pointing to our economy improving.

High-Frequency Economic Activity
Year-over-year % change; Year-over-2 year after 3/15/21*

Tracking unemployment and wage growth are two other indicators that help us understand the future health of our economy. Tracking unemployment figures is pretty straightforward. If someone is without a job, they are going to only spend money on food and housing, with virtually no discretionary spending. Wage growth is especially important to understand. For those working, are they making more or less than the year before? Higher wage growth leads to higher discretionary spending. 

We have seen unemployment steadily improve from its April 2020 highs of 14.8%. February’s 6.2% is a vast improvement, but still far above the sub 4% levels we were at prior to this global pandemic. Interestingly, wage growth has also gone up, which is typically not the case when unemployment increases. This is due to the stimulus checks many Americans received.

Civilian Unemployment Rate and Year-Over-Year Wage Growth for Private Production and Non-Supervisory Workers
Seasonally adjusted, percent

We continue to favor value over growth for the foreseeable future. Value presents the best opportunity for investors, while limiting their risk. As you can see from the chart on the right, Value continues to present the better opportunity than investing in Growth, which appears to be historically expensive.

Large-Cap Stock Valuation by Dividend Policy
Monthly 10/31/1980 - 3/31/2022 (Log Scale)

Historical U.S. Treasury Yield Curves

Bonds continue to be an area of the markets that investors should continue to underweight in their portfolios. Fed funds rates continue to sit at zero percent, with very little evidence that they will be moved up any time soon. Yields moved up significantly from August 4, 2020 lows. The 30-year treasury saw rates move from 1.19% to 2.41% over the past eight months. This move (gold arrow) caused the 30-year treasury to lose 13.5% during the first quarter.
The 10-year moved from 0.52% up to 1.74% (the blue arrow). While this move has pushed real yields into positive territory, they are hovering at only 0.46%. Do you really want to lock in a ten-year investment that will net you 1/2% per year for 10 years, assuming that inflation remains at its abnormally low rate of 1.28%? We think that inflation rates will push up to around 2 ½% to 3% over the next decade, which would mean that an investor in 10-year treasuries would lose their buying power.

Nominal and Real U.S. 10-Year Treasury Yields
1/1/1958 - 3/31/2021 (Log Scale)

Conclusion

Polaris Wealth did an incredible job identifying and investing in the correct parts of the market during the first quarter of 2021, as is reflected in your statements. We don’t think that value will outperform at the same levels that we experienced in the first quarter, but we do believe that the best opportunities are still found in this space. As a tactical investment management firm, we will continuously monitor the markets for their strengths and weaknesses and invest accordingly. We believe that the first quarter is the beginning of a value trend in the markets that could last for years.

While Polaris Wealth feels strongly about what we have written, we are never married to any belief. We will remain vigilant in evaluating the risks in the markets to determine if we need to get defensive for any reason. We feel very strongly that once we start seeing a material drop off of COVID cases in the United States, you will see investors getting aggressive about their investments in equities. The key is to be invested before these “late to the game” investors start pushing up the values in the “recovery” names that are driving the current markets. I’ll leave you with one last thought… The last worldwide pandemic we had began in 1918 and lasted until 1919. What happened after this pandemic? That’s right, the “Roaring 20s!” There is a lot of pent up demand that is not being actualized due to COVID. What do you think happens once the vaccine is fully rolled out?