Market Commentary – First Quarter 2021
2021 First Quarter Summary and Year Ahead Market Outlook
Q1 Market Summary – A Change in Market Leadership & Understated Volatility
On the surface, the first quarter of 2021 featured many noteworthy firsts: Joseph Biden took over as President, the Democrats held both houses of Congress after nearly 6 years, Coronavirus cases were on a steady decline even as the arrival of vaccines from Pfizer-Biontech, Moderna and Johnson & Johnson finally pointed to the light at the end of the Coronavirus tunnel, Bitcoin crossed the $50K threshold, the Gamestop stock whipsaw of the WallStreetBets crowd saw individual investors (at least temporarily) gain an edge over institutions and Non-Fungible Tokens (NFTs) entered the investor lexicon as the next “new new thing”.
On the market front, while Q1 2021 saw a continuation of some Q4 2020 trends especially the run up in most equity markets with the S&P up 6% YTD and International markets up 2-4%, there was a more pronounced change in market leadership with small caps outperforming large caps, cyclicals beating defensives, beaten-down value sectors such as Energy/Financials/Industrials posting 10-30% returns while prior high-fliers such as Technology/Consumer Discretionary eked out low single-digit returns. In the bond market, the most notable development was the spike in the 10-year yield to 1.7%, which roiled the bond markets and sent Treasuries & Investment Grade Corporate bonds into selloffs.
Portfolio Positioning – Asset Allocation Discipline & Mean Reversion
One of the well-worn maxims in investing is the following: “Diversification is the only free lunch”. With that in mind, we spotlight the importance of asset allocation and prudent diversification through a recent chart in JP Morgan’s “Guide to the Markets” publication. We favor this chart since it highlights mean reversion, a key tenet of investing, whereby the best and worst-performing style factors flipped spots multiple times over the past 15-20 years. To us, this highlights why we rebalance portfolios periodically and build globally diversified portfolios which are built to withstand market volatility and take advantage of various multiple market cycles.
Our Market Thoughts – Vaccines, Stimulus, Market Cycles, Interest Rates, Taxes/Spending
As we ponder what will likely be a volatile road ahead for the markets, we maintain a cautiously optimistic stance and expect that the gradual re-opening of the economy which began in Spring, to continue through summer, while ushering in above-trend GDP growth and subsequently a return to normalized sales/earnings growth for companies worldwide. Below are key drivers/topics for the year ahead:
- Coronavirus Vaccines & a Return to Normalcy. To date, we have seen a robust period of vaccinations over the past quarter globally thanks to one of the fastest vaccine deliveries on record from the likes of Pfizer-Biontech, Moderna & AstraZeneca. In the US, close to 20% of the US population has been fully vaccinated per the CDC and a 1/3rd of the population has gotten at least 1 vaccine shot, with the expectations that herd immunity should be achieved by the summer. We expect Europe will achieve herd immunity by September, and emerging market countries like Brazil and India to do so by the end of 2021. Barring any setbacks due to Coronavirus variants, this bodes well for unprecedented consumer demand and an ensuing economic recovery in 2021 and 2022.
- Federal Reserve/Congress/Stimulus, Interest Rates and Inflation. Among reasons for the swift pullbacks off March 2020 lows, the combined stimulus from both the Federal Reserve and Congress is at the forefront. The Federal Reserve slashed rates to near zero during the pandemic, boosted its balance sheet in excess of $4 trillion, and resolved to leave rates unchanged for the foreseeable future. Congress signed a $3.0 trillion stimulus plan (via the CARES act) into law last year and followed it up with a recent $1.9 trillion stimulus plan to help individuals and small businesses hurt by the pandemic, which will likely boost US GDP growth but at the expense of stoking inflation fears. We expect the 10-year to be range bound for the rest of 2021 as the Federal Reserve likely keeps rates unchanged. Bond proxies such as Real Estate Investment Trusts (REITs) and Staples, have been helpful “Tells” in forecasting the recent slowing of the ascent in rates… should they start to sell-off again later this year, they may again signal another move higher in rates (Potentially).
- Market Cycles and Investment Implications. After years of pondering whether we were in mid or late cycle, the Covid pandemic abruptly brought the market cycle to a halt and plunged us into a sharp, yet short, recession. Based on the quick rebound in Global Composite PMIs which slid into contractionary territory (i.e., readings below 50) in 1H2020 but are now in expansionary territory, and Global Real GDP growth which slid 3.6% in 2020 but is projected to hit above-trend 6.2%/4.5% growth in 2021, we are likely hovering between early-mid-cycle mode. Typically, early stages of any market cycle witness International Growth trumping US growth, which has translated into a weak dollar and outperformance of foreign markets, which trade at a 20%+ discount to historical average forward P/E ratios vs. US markets which trade at a 30% premium. They also favor Cyclical value-oriented sectors such as Industrials/Materials which benefit from robust global aggregate demand/diminished supply, and Financials which benefit from a steepening yield curve, over more defensive sectors.
- Higher Taxes/Infrastructure Spending. As of this writing, the Biden administration has proposed preliminary corporate taxation and infrastructure plans. Given that any major legislation undergoes multiple revisions before it passes through Congress, we have nothing meaningful to add now other than to state that the former will likely result in a low single-digit hit % to S&P 500 EPS, and some of the latter may have been priced into Industrials’ sector performance post-election.
Key Portfolio Changes – A Nod to Quality, Cyclicals, Small Caps & Alternatives
Recently, we wrote about how our Investment philosophy has a few key tenets in mind: preference for quality franchises or funds from top-notch investment organizations that have good track records spanning market cycles, reasonable investment valuations relative to future growth prospects, and construction of portfolios that can weather the inevitable market downturns while patiently compounding capital. We also adopt a barbell approach within our Equity bucket, splitting it into Secular Growers, Cyclical Growers and Defensive Dividend Payers and utilize a balanced approach within our Fixed Income bucket.
For instance, we made the following changes/tweaks to our investment portfolios of late, keeping a 3-5-year investment timeframe in mind:
- We added to our Home Depot (HD)/Lowe’s (LOW) positions. Within Retail, we start with retailers that Amazon would find hard to disrupt, and we believe both HD/LOW qualify amongst a handful of retailers. We favor both home improvement retailers as they benefit from strong housing tailwinds due to limited supply across most markets, rising millennial household formations, low mortgage rates and higher home-improvement spending as more corporations favor work-from-home schedules. In addition, both retailers have strong opportunities to enhance margins through better merchandising, supply chain enhancements and can post double-digit earnings growth for the foreseeable future while trading justifiably a few turns above the S&P 500’s earnings multiple.
- We enhanced our positioning in cyclical sectors including Financials (Blackstone (BX)), Industrials (Boeing (BA)), & Materials (SPDR Material ETF (XLB)) (at the expense of defensive Consumer Staples and Healthcare holdings. Consistent with our belief that institutional allocations to alternatives will only increase as investors seek non-traditional sources of income or equity-market like returns with less volatility, we believe Blackstone is a best-in-class alternatives investment firm with over $600 billion in assets, ~$150 billion in dry power with industry leading franchises in Private Equity, Real Estate, Private Credit & Growth Equity which should help it generate mid-teens AUM growth and high-teens fee-related earnings growth. In contrast, we added Boeing (BA) as our non-consensus post-vaccine return-to-normalcy play as we believe that a pickup in airline travel/ a resurgence of airline orders from major airlines favors what is in effect a global duopoly with Airbus; further, we believe that the Street will begin to value Boeing based on normalized post-Covid earnings which we believe likely occurs by 2024.
- We initiated a position in a Global Small Cap Fund from a well-recognized fund family. Consistent with our view that Small Caps globally should fare well in the early stages of a market cycle, and our view that beaten-down International markets are more favorably valued than domestic markets (i.e., the former trades at a 30% premium while the latter trades at a discount), we added to our weighting in Global Small Caps. In this specific case, we chose a Portfolio Management team that has invested across multiple market cycles, has a 20+ year track record of compounding capital in excess of its benchmarks and has reasonable side-by-side ownership within the fund.
- We continue to work on researching/enhancing our alternatives allocations. In a low-interest-rate higher-volatility world where the outlook for traditional fixed income is uninspiring and 2020 returns may have pulled forward future equity market returns, we will continue to research/allocate to areas like private real estate, private credit and hedge funds run by institutional quality firms with a track record of having invested private market capital across multiple market cycles.
As always, please let us know if you have questions.
Koa Wealth Management
11260 El Camino Real, Unit 220, San Diego, CA 92130
This material should not be considered a recommendation to buy or sell securities or a guarantee of future results. Koa Wealth Management, LLC is a registered investment adviser. Registration does not imply a certain level of skill or training. More information about Koa Wealth Management, LLC can be found in our Form ADV Part 2, which is available upon request or by visiting our website at www.koawealth.com/disclosure. Past performance is not a guarantee of future results. All investment strategies have the potential for profit or loss; changes in investment strategies, contributions, or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.
Q1 2021 PDF