Market Commentary & Portfolio Management Updates

First Quarter 2021

Contributors: Andrew Walker, Bruce Ensrud, Matt Stockman 

Click to read as a PDF.

Where We’ve Been

This past spring, we saw markets react vigorously as concerns with the unknown implications of COVID-19 grew. Policy makers followed swiftly with monetary and fiscal stimulus of an unprecedented magnitude and speed. These two competing forces ultimately caused markets to initiate a sharp “V-shaped” recovery that drastically outpaced the corresponding economic reality that many continued to live in (though, there have been improvements in the economic data as well.) Even areas of the market hardest hit by the COVID-19 restrictions (travel, leisure, restaurants, etc.) began to recover with positive vaccine developments in the late stages of 2020.

Where We’re Going

Thus far in 2021, we have continued to experience strong market returns on the back of recovering economic data and improving company earnings. Looking forward, we see some pockets of euphoria, but also plenty of areas of opportunity as economic re-openings, combined with additional stimulus and continued optimism with COVID-19 relief, are likely to be supportive of markets through at least the first half of the year.

We believe that our strategic allocations to US value-oriented equity and US small-cap equity will position us well to participate in the cyclical “reopening” trade. In addition, our continued strategic allocation to international equity serves us well with potentially overextended valuations in some pockets of US equities, the expectations for a continued weakening US Dollar and as the new administration pursues more favorable foreign trade policies.

To address concerns around market euphoria, we have cautiously reallocated a portion of core US Large-Cap equity allocations to a hedged equity position, which uses options to reduce volatility. This position would provide some downside protection should we experience any market drawdowns.

Getting Creative

A decade of easy monetary policy, followed by a massive amount of additional COVID-19 induced monetary policy, has driven interest rates to near all-time lows. While relatively low interest rates have been around for years, we are presently aware that a reopening economy, rising debt levels, and continued monetary and fiscal stimulus will create a short-term period of inflationary pressures which may cause interest rates to rise which is a concern for traditional bond holdings.

In response to this view, we have shortened our duration risk exposure in fixed income to minimize the impact that rate changes have on our portfolios. At the same time, we have taken slightly more credit risk and expanded our geographic opportunity set through a global strategic income fund that we expect will aid our continued “search for yield” in such a low-rate environment.

To further position for the inflationary pressures that we expect this year, we have introduced a real assets position into our portfolios. It is our belief that exposure to real asset prices, such as those in commodities, infrastructure, and other real assets will hold their value well throughout periods of inflation.

To adequately account for this type of market environment, we feel these non-traditional strategies are essential. And while the Environmental Social Governance (ESG) investment universe is growing with multiple suitable fund options in most asset classes, there are limited to no suitable ESG investment options in these non-traditional investment asset classes. Therefore, certain funds that are not ESG by mandate will be introduced into our ESG model portfolios. We believe the net impact of investing in an ESG portfolio will still be better than a traditional portfolio despite these changes.

A Changing Landscape

It was just 49 years ago, during the Cold War, that President Nixon met with Communist China’s then-leader, Mao, to establish a new and open working relationship with China. According to the World Bank, in 1972 the United States had a gross national product (also referred to as “GDP”, which is a common measure of a country’s economy) of $1.28 Trillion while China had a GDP of $113.7 billion. Fast forward to today, China is the second largest economy in the world, with a GDP of $14.3 trillion (representing 16.3% of the world’s GDP, versus the U.S.’s GDP of $21.4 trillion that reflects 24.4% of world GDP). In fact, new data estimates that China will overtake the U.S. as the world’s largest economy by 2028. By some metrics, China already has a larger economy than the U.S. today.

Despite China’s sizeable economy (16.3% of the world’s GDP), its stock market is underrepresented on the global state, as it only comprises 9% of the global stock market. By comparison, the U.S. represents 44% of global equity markets with 24.4% of the total work GDP. We believe this dichotomy creates a significant opportunity for investors as key drivers cause the Chinese economy – and by association, other Asia emerging economies, to comprise an increasingly larger part of global equity markets.

To position for this, we introduced an Asia-specific fund to the international equity portion of our portfolios (without increasing overall international exposure). While this fund has a healthy allocation to China equities, it also has ample exposure to India, Taiwan, South Korea, and other emerging Asian economies that are on similar (albeit smaller) growth trajectories and are poised to benefit from China’s growing global influence.

In Summary

We positioned portfolios to participate in the ongoing economic recovery while being cognizant of market risks such as pockets of euphoria, increased interest rate risk in fixed income markets, and the potential for a short term rise in inflation. We will continue to make portfolio adjustments as necessary to ensure that portfolio positioning is reflective of our current market views.

Thank you for allowing us to partner with you as we navigate the ever-changing market. We appreciate your continued trust.

If you have questions or would like to dive deeper into this quarter’s outlook, please reach out to our investment team. We’d be happy to set up a virtual coffee to talk more.

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