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1st Quarter Commentary From the Desk of Arthur D. Lyons, CIO


Equity markets continued their upward trend from last year, propelled by continued low interest rates and positive economic news. Despite occasional concerns about reopening, vaccination rates (notice very few are interested in hospitalization or death rates anymore), inflation and long-term interest rates, and overall investor interest definitely favored stocks.

Which equity market are we referring to? As mentioned numerous times last year, equity prices have been quite varied, depending on short-term investor sentiment. For example, 1st quarter total returns ranged from 6.17% for the S&P 500, to 11.24% for the value-driven (financials and energy emphasis) Russell 1000 Value. The MSCI All Country Index was + 5.14%, the DJIA + 8.29% and the small-cap Russell 2000 was the winner with +12.69%. That’s a large disparity between indices, especially considering it was only one quarter’s performance.

Despite these strong returns, it was anything but a straight line up. There were investor concerns about inflation, initially signaled by the bond market. Interest rates between February and March increased over 60 basis points for the 10-year U.S. Treasury note. This was a staggering 50% yield increase in only six weeks! Since growth stock valuations are adversely affected by higher interest rates – at least in the short term – the NASDAQ index experienced a 10% correction from mid-February to early March. Since that time it has regained over half the loss.

The catalyst for this equity rebound was due in large part to comments made by Federal Reserve Chairman, Jerome Powell. The Fed is looking for modestly higher inflation this year, including a spike to the 3% area during the summer. Overall, it feels inflation will settle between 2-2.5%, which history has shown to be a positive range for equity investors.

The modest inflation forecast calmed the bond market for the time being, but spreads remained wide between short- and long-term interest rates. This reflects some of the anticipated inflation levels preferred to by Chairman Powell. AWM&T believes that interest rates will move modestly higher during the year, as inflation trends higher, reflecting global economic growth. The Fed has said in years past that this is a good thing. Modest inflation, as currently anticipated, reflects renewed economic growth that we are all hoping for.

In the longer term, where is inflation headed? The primary concerns focus not on the labor or commodity areas, but on U.S. fiscal policy, including national debt and current spending, as they relate to real GDP and its growth rate. Will AWM&T be monitoring this? Yes. What degree of impact will fiscal policy have on investment decisions? This remains to be seen. Remember, the exact same concerns were voiced in 2009. Spending, deficit and debt were “out of control,” rising to never-before-seen levels. What happened with inflation? It actually declined, confounding even the most brilliant economists.

AWM&T’s theory, as we have stated numerous times, is that technological advances throughout every industry are driving productivity levels high enough to offset inflationary factors. It is difficult for traditional economic measurements to accurately capture the full economic benefits of these added efficiencies. For this reason, we believe inflation will be contained within the average historical level of 3.5%, despite fiscal and monetary stimulus.

Unfolding for 2021… 

The equity markets continue to operate in the favorable environment of low inflation and interest rates. As markets adjust to the recent, sudden interest rate move, we believe growth companies will resume their outperformance of so-called value type companies. We continue to look for U.S. outperformance versus the world and a resumption of large-cap versus small-cap outperformance. Keep in mind that on any given day, week, or month, strong sector “rotations” can occur. It has not been unusual to see institutional investors move large funds from one sector to another, reflecting an investor uncertainty and volatility that is historically short-term. In the longer term, we look for reduced volatility and strong corporate fundamentals from our equity allocation.

The bond market has struggled due to higher rate movement and we anticipate a tough year ahead. Already in the 1st quarter, the intermediate bond index was down -1.86% on a total return basis. As economic data unfolded during the quarter, AWM&T made portfolio adjustments to reduce interest rate risk. Additionally, we took advantage of very narrow credit spreads to reduce both investment-grade and high-yield positions, replacing them with short-term U.S. Treasury and adjustable-rate securities. While we cannot promise a positive return for the year, we can say that we have taken steps to reduce the level of interest rate and credit risk to the portfolio. This could benefit portfolios from a risk-return standpoint.

Given the risk-reward profile of these asset classes, overall allocation remains fully invested in equities, with an underweighting in fixed income.