The Economy and Market from Here... at Hills Quarter 2 2021

The Economy and Market from Here... at Hills Quarter 2 2021

April 1, 2021

Tagged As: Wealth Management

It has been just over one year since the World Health Organization declared COVID-19 a global pandemic. For many, life since has been unrecognizable compared to pre-pandemic. Millions have been personally touched by the virus and all of us have been affected. Whether it be the way we work, how we shop or the way we visit with family and friends, our lives have significantly changed. Fortunately, it appears the end, though not yet upon us, is near. Some changes will slowly fade away. But some are here to stay, forever transforming our lives and the economy.

The market is clearly anticipating an end to the pandemic and the consequential economic contraction. Over the last several months of 2020 and the beginning of 2021, stock markets have rallied as expectations for economic growth and corporate earnings continue to be revised higher. The S&P 500 ended the first quarter up 6.17% and is up an astounding 56.35% since March 31, 2020, which marked the depths of the bear market. Small company stocks – those hardest hit by the pandemic – have performed even better, up 12.70% in the first quarter and 94.85% over the latest one-year. International stocks were up as well, adding 3.48% for the quarter and 44.57% for the most recent twelve months.

Bonds have not fared as well to start the year, as long-term interest rates have moved higher. The 10-year Treasury began the year just below 1% and ended the quarter yielding 1.75%. As a result of the swift rise in yields, bond returns are down for the year. This is a short-term phenomenon: higher rates eventually mean higher income which offsets any price change. Still, lower values on bonds can be unsettling for many, as these assets are commonly considered low risk. Most of this year’s rise in the longer-end of the Treasury yield curve has been driven by higher real interest rates resulting from improved economic growth. Global real yields remain historically low and central banks stay committed to easing monetary policy as the growth outlook brightens. However, growing investor concerns regarding unexpected excess inflation add a layer of uncertainty to the post-COVID market cycle.

The economic outlook has taken a step up this quarter as vaccine access for most is anticipated to be weeks away and a $1.9 trillion COVID-19 relief package arrives at a time when there are still significant pockets of weakness in the economy. Millions of Americans are still out of work or underemployed, so many regard the package as critical to a full and timely recovery. Improvements in the consumer and cyclical sectors of the economy are signs of recovery across regions affected by the pandemic.

Looking ahead
Many economists anticipate the recovery to hit its stride by the second half of 2021, when GDP growth may surpass 5%. Projected improvement figures are based on the stimulus package, pent-up demand on the consumer side, expected progress in defeating the pandemic, and additional monetary support from the Federal Reserve.

As far as the Federal Reserve is concerned, the lead bank has indicated that it plans to keep interest rates at historically low levels for several years longer. However, Fed officials have left the door open for rising longer term rates. Many are concerned that the stimulus payments, consequent increases in the deficit, and the rush to play catchup by millions of financially strapped Americans could bring about a rise in inflation—something the economy has not had to deal with for decades. Despite that, Fed officials have insisted on maintaining supportive financing conditions for the foreseeable future and emphasized the difficulty of achieving their long-term inflation goals.

While inflation will always be a threat to long-term investors, we believe fears that hyperinflation will arise in the post-pandemic cycle are largely overblown. Though soaring oil prices and rising consumer and business spending will put some pressure on pricing, this should prove to be transitory. Production capacity and raw materials availability are adequate to meet demand, and slack in the labor force continues. Therefore, any pricing pressures should be comparatively modest. Longer term secular forces should keep inflation anchored.

It is our opinion that rising rates are more reflective of better economic growth prospects as opposed to rising inflation expectations, which is a positive for stocks. As a result, we have allowed equity holdings to drift higher with market returns this quarter. After profit-taking rebalances at the end of 2020, rising rates and favorable growth outlooks leave us comfortable with the marginal risk this year’s equity returns have given us.

We are here to answer your questions and make sure your current asset allocation is still appropriate for your circumstances. If it has been a while since you have visited with us, please do not hesitate to call or email and set up a meeting with your Hills Bank Trust and Wealth Management Officer.

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