“In the spring, I have counted 136 different kinds of weather inside of 24 hours.” – Mark Twain. This rang true as I was trying to protect my nectarine trees from a 21 degree overnight cold after we had experienced 70 degrees the day before. It was a battle, but with the help of an incandescent light bulb and a heater, the blossoms were saved. Next up – the cicadas!
I believe the economic data that we will be observing over the next 3 – 6 months, especially in the labor market, will look like Spring weather. Like in Spring, we can see that we are heading for warmer temperatures, but the path will not be a steady incline. So too will be the path into recovery, and eventually accelerating growth, as we have discussed in the past. For example, job growth in March was very strong as nonfarm payrolls jumped by 916,000. However, jobless claims for the past 2 weeks have been higher than expected. Make no mistake, the economy is continuing to heal. Leading economic indicators, retail sales leading indicators, and financial leading indicators all tell a story of an economy that will continue to climb. Currently, we expect real GDP growth in 2021 to be around 1.3% with 2022 and 2023 coming in at 2%+.
The markets responded with modest growth in the 1st quarter with a rotation into areas that benefit from the economic recovery, particularly industrials, energy, and financials. While we trust that some of the continuing growth story is built into current valuations, we believe there is additional room for growth. However, until a new leg up is established, we should expect volatility to remain high and rotation between sectors to continue. This speaks to having the portfolios positioned properly to take advantage of these moves when they do come.
The biggest surprise in the first quarter was the steep move up in interest rates. The 10-year Treasury yield at the end of 2020 was 0.93%, and by the end of the first quarter had leaped to 1.74%. This is an indication of a bond market expecting inflation, sparked by continued easy fiscal and monetary policy. As I wrote last quarter, we thought it likely rates would climb, albeit more slowly than what we have witnessed so far. While not completely surprising, as interest rates tend to initially move more quickly before settling into their path, the jump was larger than anticipated. This negatively impacted returns of fixed income in the first quarter with the iShares Core U.S. Aggregate Bond ETF (AGG) down -3.37%. Our fixed income portfolios are positioned for rising interest rates and only took about ½ of the downward movement.
The same cast of characters are at play that could cause a disruption to the recovery. Most notably would still be the government’s response to the ongoing COVID-19 situation. However, some new risks are emerging which include the likelihood of higher corporate tax rates, difficult year-over-year earnings comparisons, and the potential for boycotts over corporate speech which is increasingly political. We continue to forecast dozens of scenarios to assist in assessing risk for your portfolios.
The focus in the portfolios remains on companies with strong growth profiles and growing dividends where applicable. While we can never reduce risk to zero, we are aware the risks exist and attempt to minimize them where possible. In particular, fixed income is one area which we continue to look for ways to hedge the risk of rising interest rates.
Please do not hesitate to contact us if you have any questions and thank you for your trust.
Marc Henn, CFP®