The first quarter of 2021 was marked by a new transition as investors focused on a brightening outlook in our recovering economy, a recovery that began almost exactly one year ago. Increasingly available vaccines and gradual reopenings bolstered confidence and economic growth, not to mention $1.9 trillion of fiscal stimulus in the form of COVID-19 relief. Investors are anticipating the return to a more normal world, reflected in a new rise of bond yields, perhaps the most important change in the financial environment so far this year.
Broad US equity market indices delivered strong returns in the first quarter of 2021, with the S&P 500 gaining nearly 6.2% and the DJIA returning 8.3%. Small-cap and mid-cap US equities continued their outperformance from the end of 2020, also due to optimism for economic re-opening. Developed international equities gained 4%, while emerging markets were up a little more than 3%.
Commodities continued their upward momentum with oil prices temporarily reaching their highest levels since late 2018 before slower demand in Europe. Other materials, including copper and lumber, also increased in price during the quarter amid strong manufacturing demand and rebounding global growth. The emerging digital commodity, bitcoin, more than doubled since the beginning of the year, seeking to legitimize itself in becoming one of the most compelling asset stories to emerge since gold, all buoyed from the depreciating effects of fiat currencies amid the trillions of central banks stimulus.
However, it was a very different story for bonds in the first quarter, as the mantra goes ‘interest rates go up, bonds prices go down’. The effect on the bond market was most severe for longer term bonds which have the most interest rate sensitivity. Long-term Treasuries suffered their worst quarter in 20 years falling 13.5%, while the US Aggregate Bond declined by 3.4%. U.S. high-yield bonds were a rare bright spot on the fixed-income landscape by posting small positive returns during a difficult quarter for fixed income investors. The rise in interest rates raises concerns about inflation and may cause future bouts of indigestion in the bond markets.
Meanwhile U.S. manufacturing growth continued to increase at robust levels throughout the first quarter. U.S. services sector growth also accelerated with a substantial increase in the rate of expansion during January. A combination of steady vaccine progress and largescale stimulus has some economists projecting the fastest GDP growth since the early 1980s.
As for U.S. monetary policy, we will be watching how the central bankers respond and if they can maintain the stance of keeping interest rates near zero through 2023. It all comes down to the path of inflation. Fed Chairman Powell would like to see inflation rise moderately above 2% for a period of time before they begin to remove the punch bowl. For now, investors expect demographics, technologies, and globalization to keep inflation levels low, just as it has done in recent decades. If inflation rises in the near term, we expect it to be transitory and normalize by summer, but for now the risks of runaway inflation appear to be low.
The war against COVID-19 is not over, but the path to victory is becoming clearer. A year ago, the psychology of the market was fear but today we have optimism grounded in real economic growth, tremendous market liquidity, and rising corporate earnings. Although near-term corrections are always possible, we maintain a strategic and dynamic approach to identifying risks and seeking out investment opportunities.
If you have any questions about your portfolio or have changes to your situation and need to update your financial plans, please contact us anytime at 800-KGA-4916. As always, we thank you for the opportunity to be of service, it is a pleasure to be working with you.
Eric W. Kendrick, CFP President