ECONOMIC COMMENTARY

CIO Update: First quarter review – thoughts on stock shifts, rising yields and presidential spending

As COVID-19 vaccinations continue here in the U.S., can we look forward to a more robust economy? Shannon Saccocia, Chief Investment Officer, recaps the first quarter of 2021 and offers her take on three critical factors impacting market behavior over the next several quarters. Listen now.


Audio transcription

Hello and welcome to Boston Private Perspectives. I'm Shannon Saccocia, Chief Investment Officer at Boston Private.

I want to thank you as always for joining us today.

As hopes continues to rise as the number of Americans received at least their first dose of one of the conditionally-approved vaccines, we are also hopeful that this will translate to a sustainable bounce of economic activity that will extend well into next year. To be fair that statement minimizes some of the elevated volatility we’ve experienced in the first quarter, which we will discuss in today’s podcast and touch on again next week’s episode.

With that said, there are three main takeaways from this quarter that I’d like to discuss. First, I’d like to touch on the shift from growth to value and more specifically what is means for tech stocks going forward. Two, we’ve seen yields rising and I’d like to discuss briefly what that could mean for companies and governments over the next several years and why good news on the economy in the near term could be taken by the markets as bad news. And three, I’d like to set the stage for the potential impacts of president Biden’s plans for spending and how they could shape market behavior for the rest of the year.

Performance of growth verses value stocks (01:33)
I’ll start with the long awaited unwind of the growth trade. What we’ve experienced over the first quarter is clearly a move away from some of the stocks that have performed well last year and really over the last several years in light of the reopening trade that we are seeing taking over the market. Now, this isn’t anything new and in fact we at Boston Private have been talking about this phenomenon since well back into late summer of last year. However there have been several fits and starts where this rotation from growth to value have occurred and where we have then seen a rotation back to growth against the backdrop of concerns about the economy, or COVID-19 or any myriad of things that have thrust investors back into what we’re calling the quality camp.

In the first quarter though, we really didn’t see that. What we actually saw was a fairly disparate experience for investors in growth stocks verses those in value stocks. And breaking it down further, it’s really about what sectors are seen as more cyclical and tied to reopening than those that have potentially done well in a low interest rate, low growth environment over the last several years. So, while a lot of this has been made in buying cheap stocks that were devastated in last year’s selloff, the tenor of the market has really shifted and so a lot of those companies that had done really well in the reopening trade such as cruise lines, airlines, hotels, there’s still some momentum around those but that’s broadened out and that broadening out of the market that we’ve seen in the first quarter, is actually very healthy. So, while we were concerned over the course of 2019 and early 2020 that there was a limited number of companies that were responsible for the performance of large indexes such as the S&P 500, we’re seeing a lot more participation across sectors and subindustries than we did during that period.

But what that is resulted in is a significant divide in the first quarter between these indexes. So, for instants if you look at the Russell 1000 Index and you look at the quarterly return for the first quarter, the value index was up 11.3 % while the growth index was up just under 1%. So that thousand basis points spread or you know from our perspective 10% of difference is really consistent with the type of outperformance we saw from growth stocks over the prior years and so a lot of value investors are pointing to this and saying look it's finally time investors are recognizing the importance of value, of valuation, of fundamentals of but really this is more likely attributable to a call on economic growth going forward.

Of course that rotation hasn't been smooth and isn't going to be smooth because as there are these you know week-to-week and even in some cases in the first quarter day-to-day movement between the two sides of the trade, there will be concerns about whether this is a head fake or whether this is a more sustainable reversal. What's most important to keep in mind and what we view is that a more balanced portfolio that has some high-quality, consistently growing stocks coupled with some names that have cyclical exposure and then she brought that out to an asset allocation perspective, exposure to the more traditional S&P 500 complimented with exposure to areas like small-cap stocks, emerging markets international stocks you know all of that create some balance in the portfolio which is likely to serve an investor better in an environment where there is an undercurrent of economic growth and a widening out of the better performance of the market having a diversified portfolio in that type of environment insulates you from these day-to-day shifts and puts you in a better position to have longer-term gains.

Impacts on tech stocks (06:26)
With that said, it's important though to think about what this shift from growth to value means for tech stocks. And we talked about this consistently over the last couple of years with the rising percentage of major indices associated with the technologies sector and the importance of the top 10 names, several of which are in the technology sector to overall returns. It's important to differentiate between what were some of the highflying technology stocks of last year versus what is represented by these larger positions in something like the S&P 500. Long duration technology stocks are valued with a heavy emphasis on future earnings and low profitability. So, if you think about some of the great stocks of last year, the Zooms, Teledocs, DocuSigns, all of those valuations are contingent on the fact that these companies are going to continue to grow in an outsized rate over the next 5, 6 or 7 years.

However, when you think about the potential for an economy that's more broadly growing and the fact that you could buy stocks that have greater profitability today and are not as contingent on future growth, there is a shift that occurs away from sort of the aspirational to what you can earn in today's environment. Interestingly big technology has already underperformed for the last six or seven months or so. So, we’ve already seen this underperformance with those names. Those are actually becoming more attractive in this environment given that relative underperformance but also given the expectation that in particular you look at business spend an enterprise spend on technology that's likely to accelerate and return faster than we had anticipated given the overall economic growth that we’re experiencing and continue to experience.

In other words the death of technology stocks is probably overstated and there continues to be opportunities in the space. But if you look at our second cause of volatility in the first quarter, higher interest rates that plays into this valuation assessment as well because with higher rates over time you're looking at discounting those cash flows at a higher discount rate and it's also causing some pause because many of these companies have been able to take out very low interest-rate debt that over the last several years not only to fuel some capital expenditure but perhaps more importantly to fuel stop buy backs. And so with rising yields, we are going to see companies have more expensive access to that market. From a historical perspective, rates remain very low and in fact if we go back to 2019 we were all concerned about the inversion of the yield curve and so we were dying at that time to see this more normalized steepening of the yield curve. And so now this response is also likely overblown given the real impact of his higher rates to corporations and governments as well.

Interest rate and job data impacts (10:16)
It’s important to note here that as yields move higher, the U.S. government and other governments globally that have significant debt loads are going to be paying higher interest on that dept. And certainly that creates more pressure against the backdrop of a large fiscal spend to think about what the impact would be if we moved back to a more normalized interest rate environment, how would governments respond to that. Would that change the narrative around budgets? But I think most importantly in the near term in the next 3 to 6 months, rising yields are occurring as a result of higher economic growth and inflation expectations.

We talked about this previously but this leads to an environment where each economic data point and their response to that data point from the federal reserve another global central banks is going to be highly in-focus if we think about the most recent jobs number for instance for the month of March with over 900,000 jobs added, that certainly would have caused pause for investors who were anticipating or factoring in continued Fed accommodation over the next year and a half or so that in a previous environment would have created some concern, however the Fed has pivoted their messaging and their approach as it relates to inflation and employment and they stated this in late 2020. And it's only now that we're starting to see the application of this new policy where they're looking at eventual outcomes rather than expectations. So while there is clearly an expectation that employment and inflation is going to improve in the near term and inflation certainly going to increase, particularly on a year-over-year basis from where we were this time last year, the fed is really looking for sustainability above target.

The jobs data was really seen as a positive for the economy but should the Fed change their messaging or provide additional nuance or start to communicate that they are willing to become less accommodative because they believe that some of the higher inflation and improved employment is sustainable, then the markets are going to react more negatively to the stronger economic data. So it's going to be on a day-to-day basis very much a push and pull between good economic data which can support broader economic growth, which can support higher earnings for corporations which really should be supportive of stock prices overall with the caveat that the Fed keeping interest rates low, allows for cheaper liquidity and cheaper capital. Those two things balancing each other out is why we're going to see some intermittent volatility even as we move through into the summer.

Possible impacts of the President’s infrastructure plan (14:11)
I'm going to close on some of the volatility that is likely to be associated with the rollout of President Biden's infrastructure plan. The move to this reflationary posture that we've experienced over the last several months now is likely to be compounded by the announcement of a full-scale plan to spend trillions of dollars on U.S. infrastructure. And whether the infrastructure is the more traditional form – roads, bridges, airports, sports. Or as is more likely, it'll be a combination of traditional infrastructure and include things like digital infrastructure in order to create opportunity for technological advancement in more rural areas.

The price tag on such a package is going to be pretty significant. And a lot of the emphasis is going to be placed on one, what's in the package and is it truly infrastructure and there will be a lot of disagreement on what should and should not fall under that mantle. But what's more likely to create market volatility in the back half of the year and really starting from now onward is how this package will be paid for and I think that is said a bit tongue-in-cheek, given the deficit that we already have here in the United States and the willingness of the federal government to continue to extend that deficit in order to move us out of what was a very sharp and deep recession last year but it's important to note that how the package is paid for and what is included in the package will have an impact on the market in the back of the year and whether that this first phase of infrastructure that's paid for via increased tax rate.

It’s been talked about going from 21% to 28% now it’s being ratcheted back to 25% and then you know perhaps a second phase of what President Biden is calling I think more social infrastructure, which is investing in healthcare and education. That would potentially be offset by an increase in personal taxes. Whether its estate taxes step up or having a cap on the step up or an increase in capital gains taxes all of those can be in scope. In the next several quarters a lot of this will start to be factored into the equity markets.

And what should the reaction of longtime equity holders be to higher tax rates on their capital gains what should be the impact and what sectors and industries will be the most impacted by increases in corporate taxes

The likelihood is that corporate taxes are going to go up and the magnitude is the question. So, notwithstanding the relative economic benefit which could be substantial from such a package maybe not in 202 1 but through 2022, 2023, 2024 infrastructure packages if you go back in history tend to have a long tail and the reality is that much of the emphasis this year will be on perhaps investing in industries that can benefit from infrastructure and a lot of that’s already happened. But secondarily thinking about it in terms of where the revenue is going to come from and how could that effect your investment portfolio.

So overall those are three takeaways from the first quarter I think are really important to think about in terms of impact over the course of the next several quarters and in next week’s podcast we talk a little bit about market performance and some of the economic data that's underlined the confidence and hopefulness that is certainly running rampant in the capital markets today.

Thanks again for listening to this week’s podcast. I want encourage all of you to reach out to our team here in Boston Private with any questions or concerns you may have. If you have any questions or thoughts on my points today, you can find me on Twitter @ShannonSaccocia. You can also read our latest perspectives on the markets, the economy, taxes and estate planning by visiting bostonprivate.com. And if you want all of this information delivered right to your inbox, I encourage you to sign up for our newsletters while you’re there. And be sure to subscribe to the Boston Private Perspectives on Apple podcast, Spotify or wherever you prefer to listen. I look forward to coming to you next week.

Shannon Saccocia serves as Chief Investment Officer at SVB Private, and is responsible for setting the overall investment strategy for the firm. She oversees the asset allocation, research, portfolio management, external manager search and selection, portfolio implementation, trading, and investment risk management functions.

The views expressed in the article are those of the author and/or person interviewed and do not necessarily reflect the views of SVB Private or other members of Silicon Valley Bank Financial Group. The materials on this website are for informational purposes only, are subject to change and do not take into account your particular investment objective, financial situation or need. Since each client’s situation is unique, you should consult your financial advisor and/or tax planning professional before acting on any information provided herein