Is the Market in Hype, Hope, or Realistic Mode?

I am not sure what direction to take with this quarter’s report other than to lay out the facts. These were the significant issues, of Q1 2021, that impacted the markets. Some positively and some negatively.

• 10-year U.S. Treasury yield had the largest increase, +83 BP, since the 4th quarter of 2016, steepening the yield curve significantly. This scared growth investors but encouraged commodity, energy, financial, and industrial stock investors.
• Margin debt and leverage in the markets are at historically high levels, accentuated by the GameStop short squeeze. This event also showed that the new retail investors are extremely savvy and carry enough weight to take down a couple of hedge funds.
• The U.S Federal Reserve says inflation is not a problem as the forecast, for 2021 U.S. GDP, is somewhere between 6.5% – 8%, CPI & PPI are rising 3-4%, the 10-year U.S. Treasury rose at a record pace. Add in a $1.9 Trillion Covid package, a proposed $2 Trillion infrastructure package on the way, money pouring into cryptocurrencies like Bitcoin, and you have currency devaluation and resulting inflation looking imminent. Who is right?
• Small-Cap stocks once again outperformed their Large Cap counterparts despite a huge 4th quarter 2020 outperformance while we saw value significantly outperform growth with the largest value rotation since 2001. The question no one can answer is: will this last or will it fade.
• Investor sentiment is reaching a peak, the contrarian indicator is in the sell signal range but neither cash nor bonds are attractive alternatives to stocks. Low-quality stocks now trade at the biggest premium to high quality since the financial crisis of 2008. Ninety percent of the S&P 500 stocks are trading above their 200-day moving average. I feel this supports a continuation of the rotation from growth to value.

The majority of our portfolios benefitted greatly, with the first quarter chaos and a rotation into high-quality, value investments. We were well-positioned with overweights in energy, industrials, core tech, and healthcare names. We also did not suffer from the fixed income investments we own, as we stayed short term and high quality. As a matter of fact, our variable rate bank C.D. holdings are repricing to yields of 3.5-4.5% and should continue to move higher over the next several months.

I like how our portfolios are positioned right now and think the increase in economic growth is coming, which will bring strong earnings growth for the companies we are invested in, along with some nice dividend increases. However, there will be some costs which will include; higher interest rates, rising inflation, rising tax rates, and a tight labor market which could cap our economic growth rate. The core market is realistic, but there is also some hype and hope mixed in. We are prepared and I look forward to an exciting 2021 where it will be important to own the right mix of companies, appropriate sector weightings, and proper asset allocation to keep portfolio risk levels reasonable. The biggest question we must manage is; has the market, because of its lofty valuations, priced in all the good news? I think it has and unless we get some positive surprises, the markets will sell off a bit. However, I do not expect a reversal of the recovery scenario, limiting the downside to some of the premium coming out of some excessively priced stocks and sectors.