May 2021 | Victoria Bogner, CFP®, CFA, AIF®
We’re through the first quarter of 2021 and one year beyond the bottom of the pandemic-induced bear market of 2020. It’s hard to believe that March 23, 2020 is an entire year behind us. And back then, it would have been hard to imagine COVID still very much with us over a year later.
Although you might not realize it by looking on the surface, the first quarter of 2021 was challenging in many respects. Investor sentiment swung widely back and forth between hope for those stocks that had gotten trounced last year and enduring faith in the pandemic stocks that had done so well in 2020. Adding to these crazy double-digit stock swings were worries about inflation, interest rates, small pockets of bubbles (thanks to Reddit threads and cryptocurrencies), vaccine effectiveness, new COVID strains…the list goes on and on. This led to some pretty substantial volatility in many market sectors.
Whenever “crazy” happens, it’s important to go back to the underlying fundamentals. Let’s think this through. Over half of the US population now has their first COVID vaccine. Looking at high frequency data, we’re seeing the reopening take hold.
More people are going through TSA checkpoints, using their GPS navigation systems, staying at hotels, and making restaurant reservations. Consumers are spending their COVID stimulus checks, leading to a boost in GDP. Fed Chairman Powell has stated that the Federal Reserve is committed to keeping rates low through 2022 at least. That all translates into high GDP numbers for 2021, perhaps one of the highest numbers on record.
What about interest rates? Those were going up earlier this year. As those go up, don’t equities go down?
It turns out that since 2009, stocks and interest rates have moved together as long as rates are below 3.6%. Then they start to move in the opposite direction. 10-year Treasury yields currently stand at about 1.65%. We have plenty of wiggle room on interest rates, and even crossing the 2% threshold isn’t going to stop the stock market for long.
When we factor in President Biden’s infrastructure plan and recalculate using the capitalized profits model, the fair value of the S&P 500 goes from our original target of 4,200 to 4.500. That’s another 7.5% upside from where we are now. What that means is in our opinion, the broad US stock market isn’t overvalued at these current liquidity and interest rate levels.
With that said, we have been moving more toward exposure to sectors that will benefit from infrastructure spending and reopening while still maintaining positions in sectors that have showed strength throughout 2020, specifically those that have competitive advantages in the marketplace, investor accumulation, strong and accelerating earnings, and long-term tailwinds.
Since bonds have struggled so far this year, we’re focusing more on buffered ETFs to
provide upside potential with downside buffer protection. We’re also invested in bond funds whose managers find unique opportunities in the bond space that provide good income while maintaining conservative risk.
Speaking of risks moving forward, the biggest one we see at the moment is inflation. If it’s a bigger problem than the Fed anticipated, they may throw their current plan out the window and raise rates earlier than expected. That would slow down the economy and bring valuations back down. It doesn’t seem likely, but it’s the least impossible scenario.
But for now, we remain positive on the market and fully invested in all of our managed models. Interest rates are low, liquidity is high, the Fed is accommodative, a gigantic infrastructure plan is in the works, corporate profits are rising, and consumers are spending money. All of that points toward a rising market, although not without some bouts of volatility. That’s why it’s important to keep the big picture in mind. Don’t sweat the small stuff. Leave that to us.
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Registered Representatives offering securities and advisory services through Cetera Advisor Networks LLC, member FINRA/SIPC, a broker/dealer and Registered Investment Advisor. Advisory services also offered through Affinity Financial Advisors, a Registered Investment Advisor, operating as McDaniel Knutson Financial Partners. Cetera is under separate ownership from any other named entity.
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