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The S&P 500 stock index rose in the first quarter, continuing its strong advance since the March 2020 bottom. However, the market leadership has changed quite dramatically since the vaccination program has raised investor optimism about a full reopening of the economy. As the graph below indicates, in 2020 the technology and consumer discretionary sectors were the runaway winners while energy, financials and real estate had negative returns. Now, in 2021, those latter three sectors are leading the market while technology and consumer discretionary sectors have underperformed.
Signs of a strengthening economy are showing up in the jobs data as 916,000 new jobs were added in March, the highest total in seven months. Consumer confidence in the U.S. rose in March to its highest level since the pandemic started a year ago and retail sales were 5% higher in January than in December. Airline travel hit the highest level in a year and hotel occupancy is returning to normal levels. As the economy bounces back from the damage that lockdowns dealt it in 2020, S&P 500 earnings estimates for each quarter of this year continue to rise.
The massive fiscal and monetary stimulus and economic strength have produced fears of rising inflation and an accompanying rise in interest rates. The yield on the 10-year Treasury note has climbed from 0.91% at the start of the year to 1.72%, leading to the worst quarterly performance for US Treasuries since 1980.
Rising interest rates will also impact the historically high valuation levels for stocks. We expect that tug-of-war between rising earning and rising interest rates to continue throughout the year. A potential negative for earnings is the Biden administration’s proposal to raise corporate income taxes from 21% to 28% and increase the tax on foreign earnings. Goldman Sachs has estimated that the proposed tax increases will lower earnings by 9%. Valuation multiples may also remain at elevated levels due to the unprecedented fiscal and monetary stimulus.
In this unusual environment, we continue our research focus of finding quality companies with strong and growing free cash flow which enables them to invest in future growth while rewarding their shareholders through increasing dividend streams, share repurchases and price appreciation.
The LVM Team