With spring comes renewal, and along with it, many feel optimism for a brighter future. This spring, we see the economy beginning to re-open, jobs coming back, more and more Americans receiving the COVID vaccinations, and with that comes hope that soon this pandemic will be behind us. We hope that as we go forward, all of us will return to a happier and more fulfilling experience. We at Atlas have learned some valuable lessons in the last year, re-learned others, and feel encouraged about the future. So, as we look to the rest of the year, we offer the following observations about the markets thus far in 2021.
Equity markets showed heightened volatility in the few months of 2021, but in the end, were largely ahead of where they started. In the first quarter, the S&P 500 index returned just over 5.75%. The tech-heavy NASDAQ 100, which had been the market leader for many years, faltered. Despite an early rally, February was a difficult month for the index, and it returned just 0.06% by the end of March. Interestingly, small-cap stocks showed attractive returns, extending a rally that began last November. The Russell small-cap index was up about 12.4%, while the S&P 400 mid-cap index was up 14.8%. International stocks also provided positive increases. The EAFE Index was up almost 4%, and the ACWI-ex U.S. (All Country World Index minus the U.S.) was up just over 4%.
As for bonds, yields in investment-grade securities have increased meaningfully in recent months. The benchmark 10-year Treasury note started the year with a yield of 0.93% (having hit a closing low of 0.52% on 8/4/20), and finished the quarter 81 basis points higher, with a yield of 1.74%. This is a remarkable reversal in interest rates and is at the heart of the poor performance of the Barclay’s Aggregate Bond Index (AGG) which was down 3.69% in the quarter (remember that as interest rates rise, bond values decrease.) Outside of the Investment-Grade space, we did see credit spreads (the additional yield that an investor may receive in return for taking on credit risk) shrink. In the search for yield, it appears that investors have chosen to accept the additional risk inherent in high-yield bonds (a.k.a. “junk bonds”.) The Bank of America Single-B Option Adjusted Spread decreased from 4.23% on 12/31/20 to 3.69% on 3/31/21. The current level is well below the long-term average, and we think it represents a risk for those investors that may choose to buy into that sector at this time.
As for the economy, our outlook for the remainder of 2021 forecasts that the U.S. will experience above-average growth, moderate inflation, and modest increases in interest rates from current levels. We expect overall economic growth in the year to come in at around 6.5% for the year as the economy continues to recover from the COVID recession and progressively more businesses are re-established. As we look forward, we expect a strong second half of the year, propelling us into another good year for the economy in 2022.
U.S. corporate profits are expected to recover nicely in the first and second quarters of 2021, and continue the rebound in the second half of the year.
U.S. corporate profits are expected to recover nicely in the first and second quarters of 2021 and continue the rebound in the second half of the year. We expect earnings for S&P 500 companies to grow about 20-25% in the first quarter as compared with the same quarter last year. The second quarter could see earnings up over 50% compared to the same quarter in 2020 (remember, the economy shrank by about 5% in the 1st quarter of 2020, and another 33% in the second.) By year-end, we expect 2021 to produce earnings up about 25%. While much of this earnings power may already be priced into the market, we think that as we progress through the year these results will provide a reasonable underpinning to current equity market valuations, and a stable platform for possible further advances based on forecasts for 2022. That said, we would point out that market volatility could continue to increase as we move forward into the summer months.
We have continued to make adjustments to the sector weightings of both our stock and bond holdings to take advantage of market changes we anticipate for the future. For example, you may notice a new position in the Financial Services sector in your portfolio. With interest rates rising, a positive environment for financial services companies to lend at higher rates and increase their profitability may be present. Accordingly, we sold positions in the Communication Services sector, which served its purpose well during the past year, to fund this purchase. You may also notice other adjustments to your holdings that have been made. In addition, we took a new position in adjustable-rate bank loans in the bond portion of our strategies. With rates rising, and the adjustable feature of the rate component of these holdings, we target being able to offset the impact of rising rates and inflation. We will continue to adjust our strategies to meet the needs of our valued clients in these changing market conditions.
As always, we value the trust our clients place in us. If you ever have questions about your managed investment account or want to discuss any of our financial and retirement planning services, please do not hesitate to contact us.
Note: All market index and return figures provided have been sourced from Thompson Reuters via Refinitive Workspace.