The Calendar, And Data, Could Be Kind
April 2021
Historically speaking, April has been a profitable month for equity investors, the S&P 500 posting an average monthly return of 0.9% since 1928, trailing just December on that metric. The calendar could again prove kind for investors in stocks amid building economic optimism, an improving labor market, and ‘easy’ year over year comparisons once earnings season kicks off mid-month. As economic data improves, animal spirits and a persistent sea of liquidity should remain supportive of additional equity upside throughout the balance of this year; however, the past few months have been characterized by rotations between sectors, styles, and factors, coinciding with periods of heightened volatility as long-term interest rates have trended higher. More of the same should be expected over coming quarters.
Large cap stocks have weathered the storm that is rising long-term Treasury yields well; the S&P 500 ended March within points of an all-time closing high and began April on a winning streak. First quarter (1Q21) earnings season could serve as a positive catalyst when it begins in mid-April, with ‘easy’ year over year comparisons in place. However, investors may balk at bidding up share prices of companies that simply clear a low bar and could become more selective, rewarding companies confident enough to issue or reinstate earnings guidance. It’s notable that 1Q21 S&P 500 earnings are projected to rise 20% over 1Q20 and the onset of the COVID-19 pandemic, while growth estimates for 2Q21 are even loftier, with the consensus expecting 51% earnings growth over 2Q20. While great expectations can, if they are not met, bring greater potential downside to stocks, we don’t foresee year over year comparisons for domestic large cap stocks becoming a potential hurdle until the back half of ‘21 as companies stepped up cost-cutting efforts in the third quarter of 2020.
Expectations for increased government spending and rising inflation pushed long-term Treasury yields higher during 1Q21 and drove demand for dollars from abroad, with the U.S. Dollar Index, or DXY, ending 3.5% higher. Dollar appreciation, along with expectations that the U.S. economic recovery would outpace the global recovery led to continued outperformance out of domestically oriented small and mid-cap (SMid) companies relative to the S&P 500 during the quarter, although both the S&P 500 and Russell 2500 ended the first quarter higher, by 6.1% and 10.5%, respectively. After a pullback that began in mid-March, small cap stocks were no longer in overbought territory based on short-term relative strength indicators (RSI) as April began. The prospect of higher funding costs stemming from rising long-term Treasury yields led to profit-taking, the Russell 2000 ending March 6% below its March 15 all-time intra-day high. The months ahead may bring opportunities to increase exposure to SMid but, in our view, investors must be more discerning, buying ‘quality’ companies with little debt, as a need to roll maturing debt amid higher yields could decrease profitability and limit free cash flow generation.
Economic growth in the Eurozone remains clouded by lockdowns and a spotty vaccine rollout, but European equities have held up surprisingly well despite the persistent uncertainty. The Euro Stoxx 50 index ETF (FEZ) rose 4.7% in March alone and is up 6.7% year-to-date. European equities, and international developed markets more broadly, remain attractively valued relative to U.S. equities, and could be poised to perform well as vaccines become more widely available. Expectations remain low for economic growth in Europe and Japan, which has been the case for much of the past decade, and investors who perennially underweight foreign developed markets relative to U.S. equities could find reasons to allocate capital there as the global growth picture comes clearer into view.
We remain overweight domestic large cap stocks (S&P 500), sourcing proceeds from developed markets abroad. Over the coming months, as the global growth picture improves, moving back toward ‘neutral’ on international equities may make sense, but we expect U.S. equities to garner inflows as earnings season ramps up and improving economic data boosts confidence surrounding the U.S. recovery. We maintain a neutral allocation to domestic small and mid-cap stocks and emerging market equities. The post-election rally in smaller capitalization stocks reached an apex in mid-March, and some ‘froth’ has been worked off over recent weeks. We believe selectivity and a focus on ‘quality’ across SMid will be important moving forward, leading us to favor active management over ‘beta,’ or index-linked exposures. Emerging markets were weak throughout March amid a sell-off in Chinese equities. A weakening U.S. dollar as economic growth prospects improve abroad over coming months could be a tailwind for developing markets, but rising Treasury yields could be an offset as technology valuations may come under pressure, leading to weakness in China, South Korea, Taiwan, and other countries tethered to tech. ▲
Source: Bloomberg, Factset
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