Quarterly Review: 2021 Opens with a Changing of the Guard

SUMMARY

• Risk assets were positive during the quarter and the past twelve months.
• Cyclical stocks led performance as stimulus heightened expectations for economic recovery.
• We are utilizing a ‘barbell approach’ within our Advantage portfolios, favoring recovery beneficiaries on one end and sustainable growers at the other.

A little over twelve months ago, investors were looking for signs that the bull market and multi-year economic expansion were coming to an end. The onset of COVID-19 put an end to both, but now investors are focused on a new expansion and a new bull market with different dynamics. As we have navigated back and forth between optimism and pessimism, we have also seen leadership changes across asset classes and investment styles. The combination of massive amounts of global stimulus, accommodative central banks, and widespread distribution of the vaccine has helped fuel broader participation beyond just US large cap and growth sectors.

The table below illustrates that point as US small and mid-cap equities were the best performing asset class over the quarter as well as the trailing twelve months rising nearly 15% and 87%, respectively. With the recovery theme gaining traction, emerging markets equities have also rebounded strongly over the past year with a 58% increase. The stalwart S&P 500 continued its 12-month climb off last year’s March lows with a 6% gain during the quarter which brought the trailing twelve months gain to 56%. Perhaps there was no better illustration of investors’ general risk-on psychology than the negative performance in investment grade and treasury bonds which both saw losses in the quarter. Gold also fell 9%.

The table below shows the performance of asset classes on the left and US equity sectors on the right. Returns for both the 1st quarter and the trailing 12 months (TTM) are shown. The table is anchored by US Large-Cap equities (S&P 500 Index), which are shaded, and allows for easier comparison to see higher and lower relative performance by each asset classes and sector.

The rising tide did lift all boats as all eleven equity sectors had positive performance during the quarter and the past twelve months:

Cyclical sectors such as energy, financials, and industrials took the lead in the quarter as each sector saw double-digit year over year gains. Not surprisingly, the energy and financial sectors had the largest increases in earnings estimate revisions as Wall Street continues to raise expectations for the economic recovery. Higher expectations for the energy sector were boosted by a 22% increase in the price of oil as well as prospects for the reopened economy. Financial sector earnings also moved higher with prospects for higher loan growth and higher net interest margins.

We believe diversification and selection will be the keys to success this year:

The shift in leadership from growth to value during the quarter was also evidenced by the performance of the information technology sector. It rose only 2% during the three-month period after being the strongest performer during 2020. Ironically, a review of the sectors that outperformed the S&P 500 Index (US Large Cap in the table above) over the entire trailing twelve months confirms that a mix of both growth and value served investors well. Materials, energy, consumer discretionary, industrials, financials and information technology outperformed the index over the period. This group represents a mix of sectors that benefit from a ‘stay-at-home’ world as well as one that is in recovery mode. Our current domestic equity selection is characterized by what we refer to as a ‘barbell’ approach in order that we have diversification for both conditions. On one side of the barbell, we have increased our exposure to sectors that should benefit from the recovery and from new policies emanating from the Biden administration. These include materials, energy, industrials, cyclical consumer discretionary, and financials. On the other side of the barbell, we believe our exposures in quality branded consumer companies and technology companies offer resilience in a variety of economic conditions.

We have increased our exposure to international equities in 2021, but we believe economies outside of the US are recovering more slowly. We are encouraged by improving economic indicators in Europe and Asia but will likely wait to see confirmation of sustained improvement before increasing allocations there.

Process over Prediction:

We see a strong global synchronized economic recovery unfolding and are thus constructive on stocks in 2021. However, our near-term outlook is more cautious given the current reading from our tactical signals. RiverFront ‘s Tactical Process guides our investment decisions over shorter, three-month time horizons. As we noted in our March 1, 2021 Weekly View “The Three Rules Play Red Light, Green Light” our tactical rules are flashing caution for two reasons. We are concerned that the 200-day moving average, while continuing to rise, is doing so at what we believe is an unsustainable rate. Additionally, the crowd sentiment indicators are in extreme optimism. We believe these conditions suggest a higher probability of a short-term correction, but we believe any such correction would be temporary.