April 2021 

Key takeaways 

► Solid Quarter for Stocks 

► Not So Much for Bonds 

► History of Bond Rally 

► What’s with Inflation? 

► Diversification is crucial 

Stocks March Forward 

While meme stocks like GME (Gamestop Corp), AMC (AMC Entertainment Holdings), and KOSS (Koss Corp) – oh,  and don’t forget NFTs (non-fungible tokens) – grabbed the spotlight, ordinary value stocks carried the day to deliver solid returns. The S & P 500 returned 6.17% in the first quarter. However, the index masks a lot of volatility “under the hood.” Calmer waters on the sea surface hid a lot of disturbance deep below –  a lot of rotation was going on. What worked in 2020 didn’t so much in the first quarter of 2021 and vice versa. Growth took a back seat to Value. The Russell 1000 Growth rose 0.91% for the quarter while the Russell 1000 Value rocketed up 11.19%. Before you shed any tears for growth investors, you need to know that growth was the favored investment style in the last ten years: Russell 1000 Growth rose 16.41% annually since 2011 vs. 10.80% for the Russell 1000 Value. 

Only one of the growth darlings of 2020 mentioned in an earlier newsletter is up so are in 2021: 

• Etsy: +17.2% 
• Amazon: -2.9% 

• Tesla: -8.5% 
• Zoom: -10.8% 
• Quidel: -32.8% 

Many of the winners so far this year hail from the old economy sectors like energy, finance, industrials, and retail. A few examples: 

• Marathon Oil: +56.4% 

• L Brands: +56.2% 
• Occidental Petroleum: +52.6% 
• Ford Motor: +43.8% 
• Peoples United Financial: + 39.1% 
• JP Morgan Chase: +20.9% 

The value trend continues in US mid-cap and small-cap stocks and international and emerging market stocks too. Will it last? Value, especially in mid and small-cap stocks and international still sport relatively inexpensive P/E ratios. It could go on. 

Bonds Declined – unusual 

What usually works as an anchor in your portfolio didn’t work this time. Concerns about massive new issuance and inflation led to a dramatic fall in bonds in the first quarter. Remember: bond prices and yields move in opposite directions. The yield on the 10-year US Treasury started the year at 0.92% and finished the quarter at 1.75% – a giant leap in so short a time. The total return on the Barclays Aggregate Bond Index (Agg) fell 3.37% in the quarter. To put this in perspective, the worst year ever for the Agg was 1994 when it fell 2.9%. The Agg is a market capitalization-weighted index of intermediate-term investment-grade bonds. Around 71% of the index is government-related bonds – the highest quality.  

Why are bonds having such a hard time? Namely: Rising inflation, rising supply, and rising growth rates. Bond yields began the year at very low levels. Investors rush to US Treasuries in times of trouble. In 2020 investors rushed to bonds, especially US Treasury bonds. According to Deutsche Bank, the yield on the 10-year fell to a record 0.52% – the lowest in 234 years – on March 9, 2020, amid the start of the COVID pandemic. That day could very well mark the end of the almost 40-year bull market in bonds. The yield topped out at 15.51% on August 31, 1981. Remember 18+% on CDs and Paul Volcker? Bond yields have been coming down ever since.  

Is Inflation for Real? 

Investors are preoccupied with inflation. Will it return? Will we see double-digit rates on CDs again? Two camps are forming: one side says that the unprecedented amount of government stimulus in such a short amount of time to fight COVID-19 will overinflate the economy and lead to runaway inflation. The other side maintains that deflationary forces in the economy before COVID are still in place. Prices are not going up, but the market has still priced in inflation. Fed Chair Powell is stoking inflationary fears with his talk of allowing inflation to run higher before raising rates, and President Biden promises more stimulus spending. 

The case for inflation: 

• Savings pile-up. Many Americans are flush with cash – an extra $1.3 trillion, according to Barrons. Savings grew as stimulus checks and lack of spending during the pandemic when lockdowns prevented eating out, travel, and even commuting. According to Statista Research, in February 2021, the personal saving rate in the United States amounted to 13.6 percent, down from 19.8 percent in January. The individual saving rate was as high as 33.7% in April 2020. The average in 1960 was 11%. As notorious as Americans are about their lack of savings, you know this is significant when we’re going back to 1960. All of this money may find its way into the economy in a short amount of time when things open up – forcing a surge in prices. 
• Dovish Fed. Fed Chairman Powell has stated that he is going to let inflation run higher for longer. The average inflation target is 2%, meaning inflation will have to ride higher for longer to counter the many years when inflation was below 2%. The average inflation rate since 2010 has been 1.72%. Minding its dual mandate to maintain stable prices and full employment, the Fed also hopes to decrease unemployment and achieve a measure of social equity by letting the economy run hot so that more lower-income job seekers find jobs. In addition to low rates, the Fed’s balance sheet will continue to expand. Plans are to buy Treasuries and mortgage-backed securities of around $190 Billion per month.  
• Scarce goods. A classic catalyst for inflation is too much money chasing too few goods. We’re barely into April. There’s already a lot of evidence that factories find it challenging to keep up with demand, especially for components needed in tech (semiconductors) and housing (lumber). Shipping channels are strained – think docks at principal harbors and the Suez Canal debacle. According to GlobalPetrolPrices.com, the cost of a gallon of gasoline in Illinois has risen from $2.73 in December 2020 to $3.37 at the end of March 2021- a 23% increase in less than six months. Wait till the summer! 

The case against inflation 

• Nervous consumers. Despite flush savings, pent-up demand, and cabin fever, consumers may remain cautious about spending, worried about the virus and their jobs. Over ten million Americans remain unemployed, and the shaky vaccine rollout isn’t helping. Many Americans may take a “you first” attitude as the economy opens up. 
• Too many jobless. The economy is experiencing a so-called K-shaped recovery. Americans’ fortunes are diverging based on industry and, most importantly, education. Many of the hardest-hit sectors of the economy, restaurants, hospitality, and travel, may take a lot longer to recover. Meanwhile, most white-collar workers skated through the pandemic to work from home, keep their jobs, and grow their savings. According to the Federal Reserve Bank of St. Louis, job seekers’ unemployment rate with less than a high school diploma was 10.6% in March 2021, whereas the rate was 3.6% for those with a Bachelor’s Degree and up. It’s hard to see inflation roaring back with so many still unemployed, mainly since the hardest hit job-seekers are the ones who tend to spend most of their paycheck. 
• Spare capacity. Prices usually go up as the economy “fires on all pistons.” Right now, there’s plenty of excess capacity. Many less-educated Americans are unemployed, and the future looks murky in the sectors where many of them are employed: dining out, lodging and travel. And despite tightness in some sectors noted above, many US economy areas continue to suffer low capacity utilization, namely commercial real estate, manufacturing, mining, and energy. Some of the slowdowns are weather-related (think snow in Texas), but it may be a long time before most US economy sectors are bumping up against constraints. 

I think prices will go up in the next year or so as all of the deficit spending, stimulus, and pent-up demand wind their way through the economy. What investors, the Fed, and the White House are hoping for is an eventual leveling off or at least a very gradual increase in inflation in the next few years. 

Tailwinds remain for stocks 

Many of the tailwinds supporting the stock market since March 2020 remain in 2021. Here are a few: 

• The Fed 
• Fiscal Stimulus 
• Vaccine rollout 

• Pent-up demand 
• Strong housing 
• Manufacturing coming home 
• Tech disruption 
• Biotech boom 

By far, stocks owe their remarkable trajectory up – despite a dismal economy –  to the Federal Reserve’s extraordinary efforts. The Fed and other major central banks have lowered rates to historical lows – real rates (what’s left after subtracting inflation) are still negative – and are buying bonds of all sorts. Though yields have crept up dramatically lately, they are still relatively low by historical standards. And the Fed has pledged to keep rates lower for longer. 

The various stimulus packages passed through Congress and signed by the President also contributed significantly to stabilizing the economy and lifting stocks. With President Biden signing the latest package – The American Rescue Plan – on March 11, 2021, total spending on COVID relief is almost $6 trillion. The various packages are as such: 

• $8.3 billion. March 6, 2020: Coronavirus Preparedness and Response Supplemental Appropriations Act, 2020 

• $225 billion. March 18, 2020: Families First Coronavirus Response Act 
• $2.2 trillion. March 27, 2020: CARES Act 
• $483 billion. April 24, 2020: Paycheck Protection Program and Health Care Enhancement Act 
• $920 billion. December 28, 2020: Consolidated Appropriations Act, 2021 
• $1.9 trillion. March 11, 2021: American Rescue Plan, 2021 

America’s final bill for World War II amounted to $4.1 trillion in today’s dollars. 

Analysts are falling all over themselves daily to increase their predictions for earnings and GDP. The stock market, being a forward discounting mechanism, may already reflect a lot of this good news. The market may flatten out over the next few months as we enter the summer and fall months, usually not a great season for stocks. However, earnings and growth may continue to surprise. And a lot will depend on the scope of President Biden’s infrastructure plan. 

Stay the course. Stay diversified. 

Don’t make any wild bets. Remain diversified with a tilt toward stocks, particularly small-cap, international, and beaten-down value stocks. We’ll monitor President Biden’s ability to navigate his infrastructure plan through Congress. Despite low rates and a rocky start, I think it’s important to keep an appropriate amount in bonds. Bonds are like ballast in a portfolio. They provide income and protection in a stock market collapse. 

Please let me know if you have any questions or concerns.   

Sincerely, 

Henry 

Henry Gorecki, CFP® 

HG Wealth Management LLC 

10 S. Riverside Plaza, Suite 875 

Chicago, IL  60606 

312-474-6496 

henry@hgwealthmanagement.com