Market Commentary & Portfolio Management Updates

Contributors: Andrew Walker, Bruce Ensrud, Matt Stockman 

Click to read as a PDF.


The surging optimism created in Q4 2020 by bubbling hopes of a COVID vaccine and a potential stimulus bill started to become reality in Q1 2021. As a result, the pro-cyclical economic reopening trade that began in Q4 2020 did not slow down in the first quarter, although fears of inflation and an overheating economy put upward pressure on rates that weighed on both bonds and growth stocks.  

Looking forward, converging tailwinds associated with the reopening look to heat up the US economy to never-before-seen levels. Leaning into small caps and value should allow our portfolios to benefit from this ongoing economic improvement. International equity allocations should benefit as global economies catch-up to the US in vaccine administration.

We remain cognizant of risks that may jeopardize the otherwise rosy near-term outlook. Specifically, it is unclear what the long-term effects of so much debt-funded stimulus will bring to bear. Among other things, to manage risk in portfolios we have lowered our interest rate risk exposure in favor of strategic fixed income and real assets, diversified into international equities, and paired back on our US large-cap exposures in favor of a lower-volatility hedged equity position. 

Where We’ve Been – Q1 Review

The surging optimism created in Q4 2020 by bubbling hopes of a COVID vaccine and a potential stimulus bill started to become reality in Q1 2021. Not only were a number of highly effective vaccines approved, distributed, and administered during the first quarter, but a multi-trillion dollar fiscal stimulus package was signed into law in an effort to further buoy the finances of struggling families, businesses, and municipalities across the country. Thanks to these developments, not only are we reopening, but we have an economy to reopen to…and one on very solid footing, for that matter (all things considered)! While it comes as no surprise that economic, virus, and political uncertainties linger, we are resolute in our optimism that things will only get better from here.

In markets, the pro-cyclical economic reopening trade that began in Q4 2020 did not slow down in the first quarter, although fears of inflation and an overheating economy put upward pressure on rates that weighed on both bonds and growth stocks. In addition, a strengthening dollar weighed on international stock performance.

Market CategoryMarket IndexQ1 2021 
US Large CapS&P 5006.2%
US Small CapRussell 200012.7%
Int’l DevelopedMSCI World ex USA4.0%
Emerging MarketsMSCI Emerging Markets2.3%
US BondsBB US Aggregate-3.4%
US DollarDXY*4.0%
Source: Blackdiamond | *Yahoo Finance

Where We’re Going – 2021 Q2 Outlook

As alluded to earlier, economic growth has been picking up. Compared to a year ago when we were in the depths of the COVID-crisis, the economic data coming out today is strong – and getting much, much stronger.

Unlike prior recessions, the economic shutdown in response to COVID-19 was self-induced and met with unprecedented governmental support that effectively bridged the gap from the start of the pandemic to where we are today. As a result, we find ourselves in a surprisingly strong economic position, with the economy absorbing trillions of dollars of stimulus (with more on the way) and an enormous amount of pent-up consumer demand. Suffice to say, the economy is about to go from being on solid footing to being burning hot – in a good way. This bodes well for risk assets in the short term, as never before has this much stimulus been added to the system, let alone at a time when markets are near all-time highs.

While we are very optimistic on the US economy and US risk markets, we have identified the following risks as one to watch during the second quarter:

  • Economic Reopenings: A pickup in virus cases, re-emergence of lockdowns, faltering vaccine rollout, or a disappointment in vaccine efficacy are all scenarios that could endanger economic activity and threaten markets across the globe.
  • Inflation: As the economy reopens, pent up consumer demand from excess savings will likely outpace supply, which has been challenged by global supply chain issues, leading to inflationary pressures. In addition, the ongoing, unprecedented, and enormous amount of government deficit spending to fund non-productive programs (not unnecessary, but economically “non-productive”) are likely to create some level of inflation in the economy. Ultimately, any increase above expectations could lead the Fed to raise rates sooner than anticipated and cause markets to retreat.
  • Rising Interest Rates: Concerns around rising rates are twofold. First, there is the risk that a strengthening US Economy leads to continued higher US Rates and, in turn, further appreciation in the US Dollar. While this would likely be a net positive for US Equities, it would act as a large headwind to growth equities and international markets especially. Second, there is concern that excessive government debt issuance (to fund deficit spending) could push rates higher, especially if the Fed or foreign investors reduce their purchases of government debt.
  • Other: Other items include uncertainty around looming tax law changes (including a potential minimum corporate global tax rate), ongoing US/China trade relations, concerns related to ongoing deglobalization protectionist movements, and sporadic signs of market euphoria (Gamestop, anyone?)

Portfolio Management Updates

Our model portfolios fared well during the quarter, aided by a mid-quarter rebalancing. In the US, our existing portfolio positioning that had us underweight long maturity bonds and overweight small cap and value-oriented stocks proved beneficial given accelerating economic growth and rising interest rates. Our allocation to international equities, however, was challenged because of the strengthening dollar and its general tilt towards growth.

US economic growth should continue to be very robust on the back of vaccine administration, economic reopenings, and fiscal stimulus. This type of environment is very supportive of our continued allocation to small cap and value-oriented stocks. While we acknowledge that the pro-cyclical re-opening trade cannot persist forever, we believe that there is further room to run.

Although dollar strength thus far in 2021 has been a headwind to our international allocations, we expect there to be a point in the near-term where other global economies begin to outperform the US as they trail the US in vaccine administration and reopening efforts. Over the long-term, we continue to believe that international markets will provide better relative returns versus US markets given structural headwinds facing the dollar, better relative valuations, and stronger economic growth potential (read our Q1 Commentary here).

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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