It’s easy to forget that there was a fair amount of anxiety among investors as 2020 ended. Would new COVID variants prolong the shutdowns? Would tax selling hamper the stock market once investors were able to book gains in the new year? These and other concerns caused many professionals to start 2021 conservatively positioned (that observation is based on the options market which offers insight into such institutional positioning).
That was decidedly the wrong way to be leaning, as the stock market hit the ground running in January and blasted higher through the middle of February. Stocks wobbled over the next month as interest rates moved sharply higher. The Nasdaq (tech stocks) and Russell 2000 index (small companies) suffered sharp but short-lived -10% corrections. But by the end of March, stocks had resumed their upward trajectory and the broad market was set up to register a series of all-time highs in early April.
As positive as conditions were for stocks during the first quarter, they were equally negative for bonds. The 10-year U.S. Treasury Bond yield rose from 0.93% at the beginning of 2021 to 1.74% by the end of March. The Barclays Long Treasury Index (which tracks Treasuries 10 years and longer) fell into its first official -20% bear market in 40 years.
Driving both the stock and bond market moves was the extremely positive direction of the U.S. economy. While the first quarter opened with questions, it closed with exclamation points, as much of the economic data in late March and early April was accompanied with phrases like “best ever” or “best in 20 years.”
These signs of a rapid recovery were music to stock investors’ ears, but the bond market recognized 2020’s low yields were woefully mispriced for such significant growth — and the potentially higher inflation that often accompanies such growth. While higher yields are certainly appropriate when the economy is growing faster, the adjustment from 2020’s “sharpest slowdown ever” to 2021’s rapid recovery was jarring for longer-term bonds.
Thankfully, SMI’s strategies had no exposure to longer-term bonds, while being fully invested in stocks. As a result, most SMI investors posted solid first-quarter gains.