We are constantly working to expand our services to our clients. Last year we introduced nightly market updates around major market moves and expanded our TIPS (Taxes, Investments, Planning, Spending) newsletter.
We understand that clients can face information overload given the stock market’s endless amount of news and data from 24/7 news channels, front page news and deep dives on every imaginable topic. As your advisor, it’s our job to synthesize this information and identify a plan to meet and exceed your goals.
In this effort, this year we’re introducing our quarterly update where we provide our insights on the market and how it impacts our clients' investments.
It's our goal to provide easily understood, jargon-free insight on the markets and our clients' portfolios. If you want to dig into the details, give us a call--we're always happy to chat markets!
Second Quarter 2021: One Big Topic -- Rising Interest Rates
Last year the stock market plummeted to its quickest bear market on record. The stock market recorded some of its largest down days in history as investors grappled with the impacts of COVID-19.
This year, the bond market is taking its turn at historic losses. In the first quarter of 2021, the 10-year US Treasury interest rate moved from under 1% to 1.75%.
As interest rates rise, bond prices fall. This nearly doubling in interest rates caused US bonds to fall by nearly 4%, a historic pullback for the bond market.
This pullback marked the worst start to a calendar year for US bonds, following the best start recorded in 2020.
While 4% sounds meager, this loss is significant given the inherent differences between stocks and bonds. While stocks have an infinite upside, the best-case scenario for a bond is an investor receiving all their interest and original purchase price.
This means large bond drawdowns can take longer for investors to reach high water marks.
With the bond market yielding under 2%, it will take more than two years for bonds to recoup the losses from the first quarter of 2021. Conversely, the stock market’s losses in 2020 were fully recouped before year-end.
What’s Driving Rising Interest Rates?
Since the market nadir a year ago, the stock market and greater economy have been supported by tremendous fiscal stimulus from governments around the world.
Just how much has the stock market bounced back?
Below is the Dow Jones 1-year return compared to all other 1-year returns since 1915.
This spectacular growth is the result of investors considering the impact of global GDP’s bouncing back and the possibility of inflation. As investors assume greater inflation, this increases the interest rate in the economy and in the bond market.
On one hand, higher inflation is positive because it assumes a healthy economy, but for retirees, this can be a double whammy in falling bond prices and an uptick in the goods and services used daily.
For retirees, this emphasizes the importance of having equal to or more than enough portfolio income to meet spending needs. Retirees who are selling bonds to meet increased spending needs are selling at inopportune times.
Inflation note: Few investors are expecting the inflation experienced in the 70’s. Many economists have modeled an economy “running hot” with inflation at 3 – 4%. With the lack of population growth, it’s much more unlikely for an economy to reach inflation of 20% that was reached at the peak of “Stagflation.”
Going Forward —Bonds
In our income producing portfolios, last year we recognized that US Treasury bonds yielding 1% were simply not viable investments for our clients. We opted to move into high quality and high yielding corporate bonds.
These higher yielding bonds first yielded more than 6% as we purchased them during the crisis. Today they yield less than 4% as investors realize an improving economy provides a tailwind for corporations to repay their debts.
The chart below highlights the additional income investors receive from investing in high yield bonds.
Early 2020 concerns around defaults have subsided as more stimulus and inflation has entered the economy. As a result, investors are no longer compensated as much of a premium for owning these bonds.
On the other hand, the rising interest rates have hindered the performance on our emerging market bonds. As interest rates rise, the market finds this set of bonds to be less attractive because investors can receive now higher income from institutions perceived to be higher quality. Naturally investors would be willing to invest in a stronger bond than a risker one, with all else equal.
Going Forward – Stocks
Naturally, the same economic rebound story is affecting the stock market. In the first quarter, US companies between $200 million and $2 billion, referred to as small cap companies, returned 19% vs the 8% return in the S&P 500.
As small cap companies derive more of their sales and growth from the US market, they benefit from the rebounding US economy. Additionally, these stocks had lagged the larger companies during the pullback, meaning they were cheaper and more attractive to investors heading into 2021.
By owning stocks outside of the S&P 500 our clients have benefited from the diversification in US and international stocks.
Small and mid-cap companies have shown to be strong performers over the long-term. This can come at the cost of short-term underperformance, like in 2020 when the S&P 500 strongly outperformed both small and mid-cap companies.
In 2020, the S&P 500 performed incredibly well as it was buoyed by big tech stock performance. Now as the economy rebounds and smaller firms benefit, investors stand to gain from diversification in their stock holdings.
This rotation highlights the importance of having a well-constructed portfolio for the long-run. Understanding what, how and why to own different sets of investments gives investors the comfort to withstand short-term pullbacks and be positioned for long-term success.
Disclosure: Delta Wealth Advisers is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
Delta Wealth Advisers has included and discussed displays, charts, graphs, or formulas which are not intended to be used by themselves to determine which securities to buy or sell, or when to buy or sell them. Such charts and graphs offer limited information and should not be used on their own to make investment decisions.