Quarterly Review: 2021 Opens with a Changing of the Guard | ETF Trends

By Rebecca Felton

Cyclical Sectors Responded Well to Vaccines, Stimulus, and Pent-up Demand

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.

Important Disclosure Information

The comments above refer generally to financial markets and not RiverFront portfolios or any related performance. Opinions expressed are current as of the date shown and are subject to change. Past performance is not indicative of future results and diversification does not ensure a profit or protect against loss. All investments carry some level of risk, including loss of principal. An investment cannot be made directly in an index.

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Technology and Internet-related stocks, especially of smaller, less-seasoned companies, tend to be more volatile than the overall market.

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Sectors based on Global Industry Classification Standard (GICS) a standardized classification system for equities developed jointly by Morgan Stanley Capital International (MSCI) and

Standard & Poor’s. The GICS hierarchy begins with 11 sectors and is followed by 24 industry groups, 67 industries, and 147 sub-industries.

Standard & Poor’s (S&P) 500 Index TR USD (US Large Cap) measures the performance of 500 large cap stocks, which together represent about 80% of the total US equities market.

Asset Class Definitions:

S&P 1000 Index TR USD (US SMID Cap) is a combination of the S&P Mid Cap 400 Index TR USD & S&P Small Cap 600 Index TR USD.

MSCI EAFE Index TR USD (Developed International Equities) is an equity index that captures large and mid cap representation across developed market countries around the world, excluding the US and Canada.

MSCI Emerging Markets Index NR USD (Emerging Market Equities) is an equity index that captures large and mid cap representation across 23 emerging markets (EM) countries.

Bloomberg Barclays Capital US Treasury Index TR USD (Treasury Bonds) measures the performance of the US Treasury bond market.

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ICE BofA Merrill Lynch High Yield Index TR USD (High Yield) which tracks the performance of US dollar denominated below investment grade rated corporate debt publicly issued in the US domestic market. Index constituents are capitalization-weighted based on their current amount outstanding times the market price plus accrued interest.

Bloomberg Barclays Capital 1–3 Month US Treasury Bill Index TR USD (Cash) includes all publicly issued zero-coupon US Treasury Bills with a remaining maturity between 1 and 3 months, are rated investment-grade, and have an outstanding face value of $250 million or more.

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