In the first quarter of 2021 (Q1) stocks had a volatile start but ultimately edged higher. Cyclical stocks, those most sensitive to economic expansion, led the market—building on outperformance that began with positive vaccine news in November of 2020.
Global economic reacceleration continued with signs of a solid manufacturing recovery. New orders have been increasing to fill still modest inventory levels, and the IHS Markit US Composite purchasing managers’ index rose to the strongest reading in almost six years.
These positive changes accompanied a recovering US economy, resulting from much-needed federal COVID-19 aid and increased vaccine availability.
Here, we cover the main factors affecting the market in Q1, including improving labor markets, lower interest rates, vaccine rollouts, and more.
US Economic Recovery and Reopening
The US economic reopening is spurring an improving labor market. The unemployment rate declined to 6%, and nonfarm payrolls rose by 916,000 in March—growth that was well ahead of estimates and the fastest since August 2020.
Consumer activity measures have also posted strength. And while consumption is also improving outside the United States, for the most part it has been trailing the United States as other parts of the world continue to contain the spread of COVID-19.
The key drivers of the rotation to more cyclical parts of the market were the $1.9 trillion fiscal package passed in December, continued monetary policy support, an uptick in vaccine supply and distribution, and ample corporate and consumer cash waiting to be deployed.
In addition, details from the potential multitrillion-dollar infrastructure package from the Biden administration have begun to surface.
Low Interest Rates
A recent spike in longer dated bond yields provided some discomfort to stocks in Q1, in particular the higher valuation growth stocks that performed so well in 2020.
For the higher multiple stocks, higher yields mean that valuations can rerate lower when valuing them on a discounted cash-flow basis. Because these high-growth stocks have a long duration in their cash-flow and growth prospects, they reap the greatest benefits from low rates and, in turn, have pulled back as rates normalize upward.
Importantly, however, today’s Federal Reserve (Fed) isn’t contemplating near-term tightening, and interest rates are still very low on a historical basis. This is still a level that seems supportive of stocks.
Continued COVID-19 Vaccine Progress
Markets are pricing in the positive vaccine news in the United States. The Biden administration has indicated that the United States will have enough vaccines for all adults by mid-April.
Efficacy data shows that the current vaccines are effective in preventing severe disease and hospitalizations, which means the economy could be returning to more normal conditions by summer.
COVID-19 virus variants are perhaps the biggest risk to the restart, yet clinical data has shown current vaccines demonstrate sufficient efficacy against the known mutations—enough to provide immunity and alleviate hospitalizations, giving the markets confidence that the economy will continue to recover.
Strong Fourth-Quarter Earnings
Fourth-quarter earnings strongly beat consensus analyst estimates as well as what was mostly conservative company guidance. Economically sensitive sectors and stocks have the most potential to surprise to the upside in coming quarters, and this has been reflected in the price momentum for sectors such as energy, materials, and financials.
The more defensive growth companies that outperformed in 2020, such as companies that benefitted from the stay-at-home economy, may find it more challenging to exceed prior-year earnings levels for the next couple of quarters. However, many of these stocks have already rerated lower, and it seems the longer-term secular trends behind sectors such as technology make them a core holding for investors.
It’s still advised to maintain a balanced approach in portfolio allocation with a bar bell of exposure to both the cyclical economic recovery and the longer-term secular trends of technology and innovation.
Eurozone business activity rebounded in Q1, although the area has struggled some with extended lockdowns and tensions over vaccine supplies. In emerging markets, it’s been a mixed picture. However, similar to other major markets, there’s been a rotation from growth stocks to value stocks as economic recoveries broaden globally.
Heading into Q2, risks to the economy and markets remain, including uncertainty surrounding the trajectory of the recovery, continued momentum on the health response to the virus globally, scope and size of fiscal stimulus, and potential for upward revisions to taxes.
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