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Quarterly Summaries

2021 Quarterly Summaries

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Review of Securities Markets, First Quarter, 2021

U.S. stocks registered strong gains in the first quarter, supported by prospects for faster economic growth. Economists expect U.S. economic activity to accelerate over the course of the year as increased Covid-19 vaccinations and declining new virus cases unleash pent-up demand. Reflecting these positive developments, the Federal Reserve increased its forecast for full-year growth to 6.4% in mid-March. In addition to the positive news on the Covid front, Congress passed the $1.9 trillion stimulus package, which should provide an additional boost to growth. The S&P 500 Index1 of large company U.S. stocks gained 6.2% during the quarter while smaller companies posted even higher returns; the Russell 2000 Index2 of U.S. small company stocks gained 12.7%.

Some of the biggest gainers during the first quarter were economically sensitive stocks such as energy and financial companies, which lagged the market last year in the face of the Covid-induced recession. Information Technology was one of the weaker performers among S&P 500 sectors after leading the market in 2020.

Foreign stocks generated solid returns during the first quarter as the MSCI ACWI ex U.S. Index3 gained 3.5%, reflecting gains in most developed and emerging markets. Appreciation in the U.S. dollar moderated the return U.S. investors earned on their foreign stock holdings.

In contrast to stocks, high-quality bonds posted negative returns during the quarter, as investors responded to increased inflation concerns by demanding higher yields for longer- maturity bonds. The Barclays Aggregate Bond Index4 of high-quality U.S. bonds declined 3.4% during the first quarter while the shorter-maturity Barclays 1-5 Year Government/Credit Index5 declined 0.6%. The yield on the benchmark 10-year U.S. Treasury note nearly doubled from 0.9% at the beginning of the year to 1.7% as of March 31st even as the Federal Reserve kept overnight interest rates anchored at close to zero.

The Votes Are In

Years ago, Warren Buffett astutely observed that “in the short-run, the market is a voting machine, but in the long-run, it is a weighing machine.”6 Buffett’s point was that stock prices at any point in time are driven strongly by investor sentiment and emotions such as fear and greed. Over longer periods, however, these short-term emotional factors and investor preferences tend to even out and stock prices reflect their underlying economic value.

At the present time, the voting machine is clearly registering a preference for optimism and higher stock prices. The narrative is one of, “With interest rates so low and the economy poised to rebound, stocks are the place to be.” This mindset is captured by a new acronym, “TINA,” or “There is no alternative” to stocks.

One indicator of the current buoyant mood is the level of margin loans outstanding. This represents the amount investors have borrowed against their investment accounts. According to the Financial Industry Regulatory Authority (FINRA) and the Wall Street Journal, margin loans outstanding reached a record $814 billion in late February. More tellingly, the rate of increase in margin balances was up 49% over the past 12 months.

To be clear, margin loans in and of themselves are not necessarily imprudent. In fact, we recommend margin loans in specific situations, particularly as short-term bridge loans often tied to real estate transactions. However, the large recent increase in margin loans suggests that many investors are not using these loans as temporary bridge funding but rather as a way to juice portfolio returns via leverage by borrowing to invest in more stocks.

And margin loans balances only tell part of the leverage story. Lightly regulated investors such as hedge funds often use derivative securities to increase their leverage. Since many of these derivatives transactions are between private parties such as banks and other institutional investors, it is very difficult to gauge the magnitude of leverage among these investors. Nevertheless, recent developments in this corner of the marketplace are concerning. Over just the past few months, three large funds have collapsed (Archegos Capital, Greensill Capital and Melvin Capital). In each instance, excessive leverage combined with a decline in some of the underlying funds’ investments led to forced liquidations that wiped out the funds’ equity.

Another familiar saying in the market is admittedly a bit cruder than Mr. Buffett’s observation but perhaps equally as astute – “pigs get fat but hogs get slaughtered.” The current conditions of a strong upward swing in stock prices and very low borrowing rates are a dangerous mix for investors who don’t understand that market trends can reverse in a heartbeat and that they most likely won’t see the reversal coming. By assuming too much risk, these investors may be violating the number one rule for successful long-term investing: “Make sure you’re around for the long-term.”

Source for data and returns: Morningstar

1. S&P 500 Index: A market capitalization-weighted index that generally contains the 500 largest publicly traded stocks in the U.S., subject to certain restrictions. An index is unmanaged and not available for direct investment.

2. Russell 2000 Index: A market capitalization-weighted index of U.S. small cap stocks that consists of the 2,000 smallest publicly traded stocks in the Russell 3000 Index. An index is unmanaged and not available for direct investment.

3. MSCI ACWI ex US Index: A market capitalization-weighted index that captures large and midcap companies in developed and emerging market countries excluding the U.S. An index is unmanaged and not available for direct investment.

4. Bloomberg Barclays U.S. Aggregate Bond Index: A broad-based bond index that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government agency bonds, corporate bonds and securitized fixed income securities. An index is unmanaged and not available for direct investment.

5. Bloomberg Barclays 1-5 Year Gov/Credit Bond Index: A broad-based bond index that measures the non-securitized component of the US Aggregate Bond Index and targets bonds with maturities between 1 and 5 years. An index is unmanaged and not available for direct investment.

6. There is some debate as to whether this quote should be attributed to Benjamin Graham, Warren Buffett’s mentor, rather than Buffett himself. Graham provided the metaphorical framework for this observation in his 1934 book, “Security Analysis,” and Buffett has graciously attributed the quote to Graham even though it doesn’t appear in any of Graham’s works.

Written by Rich Golinski, CFA, Chief Investment Officer; [email protected]

Quarterly Review of Securities Markets: Total Return

Index7MarketYTD (3/31/21)
Standard & Poor’s 500Large Co. U.S. Stocks6.2%
Russell 1000 ValueLarge Co. Value U.S. Stocks11.3%
Russell 2000Small Co. U.S. Stocks12.7%
MSCI All-Country World ex U.S.Foreign Stocks3.5%
Barclays 1-5 Year Gov’t/CreditU.S. Shorter-Term Taxable Bonds-0.6%
Barclays Aggregate BondU.S. Taxable Bonds (Broad-based)-3.4%
Barclays 1-5 Year Muni BondU.S. Shorter-Term Tax Exempt Bonds0.1%
JPMorgan Global Ex-U.S. BondsHedged Foreign Bonds-2.4%

Key Economic Indicators

  • The latest U.S. GDP growth figures (fourth quarter 2020) showed the economy contracted 3.5% last year. The initial estimate of first quarter GDP will be released in late April and consensus expectations are currently calling for annualized growth of about 4%. Economic activity is expected to pick up as the year progresses due mainly to the roll out of COVID-19 vaccines. U.S. GDP growth is expected to be in the range of 6%-7% for all of 2021.
  • U.S. employment data for March showed a marked improvement. Nonfarm payrolls rose by 916,000, which was significantly higher than expected. Most of the unanticipated gains came from industries that were impacted the most by COVID-19, such as leisure and hospitality. Despite the improvement, the U.S. economy has still lost about 8 million jobs since the pandemic began. The unemployment rate improved to 6.0%, but remains well above the 3.5% unemployment rate reached before the pandemic began.
  • The latest report on U.S. inflation (Consumer Price Index) showed an inflation rate of 1.7% in March versus the same month a year ago. The Core Consumer Price Index (CPI less food and energy) posted an annual increase of 1.3%. Inflation is expected to rise over the next couple of quarters due to the anticipated increase in global economic activity, but the inflation rate is expected to drop back to the 2% range in the U.S. by the end of the year.
  • The Bloomberg Commodity Index gained 6.9% during the first quarter. The price of crude oil rose 22% during the period due to increased manufacturing and consumer demand. The price of oil ended the quarter at $59 per barrel. Gold declined 10% and ended the quarter at $1,708 per ounce.

Key economic indicators compiled by Jeffrey Blanchard, CFA, Director of Research; [email protected]

7. Index Glossary:
Standard & Poor’s 500: A market capitalization-weighted index that generally contains the 500 largest publicly traded stocks in the U.S., subject to certain restrictions. The index includes the reinvestment of dividends. An index is unmanaged and not available for direct investment.
Russell 1000 Value Index: A market capitalization-weighted index composed of constituents in the Russell 1000 Index with low price to book ratios and lower forecasted growth rates. An index is unmanaged and not available for direct investment.
Russell 2000 Index: A market capitalization-weighted index of U.S. small cap stocks that consists of the 2,000 smallest publicly traded stocks in the Russell 3000 Index. An index is unmanaged and not available for direct investment.
MSCI All-Country World ex U.S.: A market capitalization-weighted index that captures large and midcap companies in developed and emerging market countries excluding the U.S. An index is unmanaged and not available for direct investment.
Barclays 1-5 Year Gov’t/Credit: A broad-based bond index that measures the non-securitized component of the US Aggregate Bond Index and targets bonds with maturities between 1 and 5 years. An index is unmanaged and not available for direct investment.
Barclays Aggregate Bond: A broad-based bond index that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government agency bonds, corporate bonds and securitized fixed income securities. An index is unmanaged and not available for direct investment.
Barclays 1-5 Year Muni Bond: An Index that covers the USD-denominated tax exempt bond market with maturities of 1-5 years. The index includes state and local general obligation bonds, revenue bonds, insured and prerefunded bonds. An index is unmanaged and not available for direct investment.
JPMorgan Global Ex-U.S. Bonds: An index constructed of government bonds issued from developed countries outside the U.S. with the currency exposure hedged backed to the U.S. dollar. An index is unmanaged and not available for direct investment.

Disclosures:

The information presented within is for informational purposes only and is not intended to be used as a general guide to investing or financial planning, or as a source of any specific recommendations, and makes no implied or express recommendations concerning the manner in which any individual’s account should or would be handled, as appropriate investment or financial planning strategies depend upon the individual’s specific objectives. It is the responsibility of any person or persons in possession of this material to inform himself or herself of and to seek appropriate advice regarding, any investment or financial planning decisions, legal requirements, and taxation regulations which might be relevant to the topic of this report or the subscription, purchase, holding, exchange, redemption or disposal of any investments.

The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk. Past performance is not indicative of future results, which may vary. The value of investments and the income derived from investments can go down as well as up. Future returns are not guaranteed and inherent in any investment is the potential for loss.

This report does not constitute a solicitation in any jurisdiction in which such a solicitation is unlawful or to any person to whom it is unlawful. Moreover, this report neither constitutes an offer to enter into an investment agreement nor an invitation to respond by making an offer to enter into an investment agreement.

Opinions expressed are current opinions as of the date appearing in this material only and are subject to change. No part of this material may, without the prior written consent of Bingham, Osborn & Scarborough, LLC, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient.

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