Roughly a year after hitting its COVID-driven bottom on March 23, 2020, the S&P 500 finished 2021’s first quarter near its highest level on record, gaining 6.17% in Q1 and 56.35% over the trailing 12 months. The quarter was not free from volatility, however, as concerns over future inflation and higher interest rates weighed on performance of growth stocks, which eked out a gain of just 0.94%. Outside of the U.S., international and emerging equities, faced with the headwind of a strengthening dollar, found themselves slightly behind the S&P 500 at quarter-end, with respective gains of 3.48% and 2.29%.
Fixed income markets have faced a great deal of challenges thus far in 2021, with the yield on the U.S. 10-year treasury rising to an intra-quarter peak of 1.74%. This drove returns into negative territory for just about all major fixed income sectors and led to a YTD decline of -3.37% for the Barclays Aggregate Bond index. High yield corporate bonds were one of the few fixed income asset classes to end the quarter in positive territory, +0.85%, as these inherently riskier bonds benefitted from their equity market sensitivity and lesser degree of interest rate exposure (i.e. duration).
Q1 saw the continuation of a trend that began in September of 2020. That trend being a reversal in leadership from growth to more value and cyclically-oriented assets, as the U.S. economy has moved toward reopening and investor sentiment has improved. In particular, during just the first quarter, large value stocks outperformed their growth counterparts by more than 10.00% (+11.26% vs. +0.94%), while small value stocks gained over 21%. This gap grows even wider if we step back into 2020, where we see large value stocks with a commanding 19% lead over large growth stocks (+26.16% vs. 7.15%) from just September 1, 2020 through the end of Q1 2021, and gains of over 43% for U.S. small value.
A change in leadership has emerged for non-U.S. and emerging markets stocks over the same time period, with the MSCI EAFE gaining 16.96% from 9/1/2020 through 3/31/2021, while the MSCI EM index gained 20.47%. Both outpaced the gain of the S&P 500 over the same period, with the U.S. equity benchmark gaining 14.55%. One caveat, however, is that non-U.S. assets have seen headwinds more recently, as higher U.S. interest rates and concerns over the COVID-19 virus outside the U.S. have caused the dollar to rally by more than 4% off its January low.
Sharply higher interest rates have created difficulties for fixed income investors for much of 2021, as the yield on the U.S. 10-year treasury note, peaked at over 1.70% in late March, its highest level in more than a year. This put significant pressure on the prices of most investment grade securities, particularly those with the greatest degree of duration or interest rate risk. More specifically, investors witnessed a YTD decline of -3.37% for the Barclays Aggregate Bond index and steeper losses of -4.25% for treasuries and -4.45% for investment grade corporate bonds. To put this into historical context, Q1’s loss for the BarCap Aggregate Bond index, corresponds to one of its worst starts to a calendar year in 40 years, exceeded only by an -8.71% decline in Q1 of 1980.
High yield corporate bonds were one of the few fixed income asset classes to produce positive returns in Q1, as they benefited from gains in the equity markets and investors’ desire for yield. The asset class was also helped by a duration that is roughly 2.5 years less than the benchmark investment grade index, indicating significantly less interest-rate sensitivity. Unfortunately, this lessened degree of interest rate risk is offset by the additional amount of credit risk investors must take on to own these securities. The degree of credit risk can be measured by the spread that high yield bonds offer versus comparable treasuries, which at quarter-end stood at just above 300 bps, its lowest level post-financial crisis. This leaves little room for error, as it relates to the pricing of below-investment grade or “junk” bonds.
Despite trailing on the month, broad-basket commodities ended Q1 as one of the market’s top performing assets, with a return of 6.92%. YTD returns have largely been driven by commodities associated with the reopening trade, such as crude oil, which has gained over 22%, and copper, which has advanced by more than 13%. Precious metals have been the only major laggard, as higher interest rates have made safe-haven, store-of-value assets, like gold and silver, less attractive to interest seeking investors.
Closed End Funds
Closed end funds have thus far overcome the headwind of higher interest rates, as strengthened investor optimism and a desire for yield have caused discounts to narrow for much of the universe. To quantify, over just the last three months, the average universe discount has declined by nearly 250 bps, adding meaningfully to returns for CEF investors. iCM’s Tactical Income Closed End (TICE) strategy benefitted from this trend, as returns for the 40% Equity/60% Fixed Income strategy trailed the all-equity S&P 500 by just 81 bps (+5.36% vs. +6.17%) and outperformed its blended index by 446 bps.
Monthly “Market Flash” is intended solely to report on various investment views held by Integrated Capital Management. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable, but should not be assumed to be accurate or complete. References to specific securities, asset classes and financial markets are for illustrative purposes only and do not constitute a solicitation, offer or recommendation to purchase or sell a security.
Past performance is no guarantee of future results. Please note that investments in foreign markets are subject to special currency, political, and economic risks. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index.
Strategy performance results are net of fund expenses, gross of advisory fees and other expenses that would be incurred in the management of client accounts, such as commissions, transaction fees, and/or custodial charges, and reflect the reinvestment of dividends and capital gains. The client’s return will be reduced by the advisory fees Integrated Capital Management, Inc. charges for the management of an account. Individual account performance and investment management fees incurred by clients may vary as fees for smaller accounts are higher on a percentage basis than for larger accounts. Investment return and principal value will fluctuate, so shares, when redeemed, may be worth more or less than their original cost. For additional information regarding advisory fees, please review Integrated Capital Management, Inc.'s Form ADV Part 2A.
TICE Blended Index comprised of 32% S&P 500/8% MSCI EAFE/38% Barclays Aggregate Bond/20% Barclays Municipal Bond/2% Cash