Q1 2021 Insights
The continued recovery from the Covid recession translated into strong returns for global equity markets and negative returns for bonds in the first quarter. The “risk-on” reflation trade is under way, reversing long-established market trends that, to many investors, were beginning to seem like second nature. Unlike the past several quarters (and years), growth stocks did not beat value stocks, large caps did not outperform small, interest rates did not decline, and long-term bonds did not help portfolios. Whether this is the beginning of a longer-term movement or a short-term phenomenon amid the current economic backdrop remains to be seen. What the first quarter of 2021 truly showed investors, however, was the benefit of remaining well-diversified across all sectors and investment styles. It also demonstrated the benefit of prudently managing risk, especially in fixed income.
At moments such as this, it is important to maintain objectivity, not lose sight of your long-term strategy, and not get mired in uncertain distractions. In the quarter, the sharp contrast of a swift recovery in markets and an accelerating economy versus the rising risk of Covid reclosures (e.g., India) and expensive policy proposals (e.g., the U.S.) have some investors questioning if it is time to double-down, or head for the exits. To the fearful and greedy investor alike, we seek to temper expectations.
For those investors questioning the merit of remaining invested in equities, we would first point out that while valuations on the whole are higher than average, the market remains heavily concentrated at the top in the most overvalued names¹ whereas the remainder is more fairly valued. Second, while there are certainly pockets of overvaluation (and overexuberance) that have garnered a lot of attention in financial and social media, these areas are not indicative of the overall equity market. Finally, and most importantly, while corrections are normal and should be anticipated over the near term, equities remain more attractive than fixed income, especially for the long-term investor.
To those seeking to make their portfolios more aggressive as the economic recovery gathers further momentum, we would remind them that in the short term the economy does not equal the market, and the market does not equal the economy. Markets are forward-looking entities, and over the past few months they have already begun pricing in the recovery and expansion we are currently witnessing in the real economy. While ultra-accommodative monetary policy may continue to support equities, any negative headlines, particularly related to Covid cases and vaccine rollouts in emerging markets – not to mention political jostling around additional spending and taxation plans – could trigger a short-term correction. The VIX² continues to be low, but we anticipate higher volatility as this recovery evolves. Finally, given interest rates are still low (by any historical measure) and equity markets are already fairly valued, future expected returns may be lower than they have been in recent years (see Appendix A).
In this environment, we believe it is better to be prudent. We are adhering to our clients’ personalized investment strategies. We continue to rebalance portfolios to their long-term targets, putting them in line with what we believe to be an acceptable level of risk given each client’s goals, time horizon, and liquidity needs.