COMMENTARY FROM THE INVESTMENT COMMITTEE OF CORAL GABLES TRUST COMPANY
Q1 2021 - Gathering Steam
With social-distancing restrictions easing, fresh fiscal stimulus measures from Congress, combined with a new vaccine entrant in the battle against Covid, the path to a broader reopening is becoming clearer. As the economy recovers from the effects of the pandemic, economically sensitive stocks stand to benefit. This was evident in the first quarter as we witnessed not only a rotational shift toward the value areas of the market, but a change in performance leadership. We believe this is forming a healthier market where more stocks are participating in the rally, unlike last year in which growth stocks were responsible for most of the market performance. The S&P 500 ended the quarter near an all-time closing high, returning +6.17%. Due to the brisk rise in longer term U.S. Treasury rates, the technology heavy NASDAQ took a pause returning a modest +2.78% for the quarter. The Russell 2000 small-cap benchmark ended the quarter with a return of +12.44%. Strong performance from small-cap is indicative of a stronger economy ahead, however, future performance could level off as corporate earnings and valuations resume focus. Investors anxiously await first quarter earnings which are forecast to grow +22.6% from Q1 2020 of last year.
On the economic front, the employment data released for the quarter was better than anticipated with the unemployment rate dropping to 6.20% compared to the 6.70% experienced in the fourth quarter of 2020. The pace of the recovery is starting to pick up steam with 379,000 jobs added in February. This was a welcome change of events for a suppressed labor market as we begin to turn the helm on a restrained economy. However, the unemployment rate understates the degree of dislocation in the labor market. While the number of unemployed people is 4.3 million higher than a year ago, the labor force is 4.2 million smaller. Congress passed the $1.9 trillion American Rescue Plan, which will provide support to these individuals in the form of a $300 weekly boost, extension of the pandemic aid through September 6th, and offering a new tax waiver on the first $10,000 of unemployment benefits. While these substantial stimulus measures will have long term ramifications on inflation and U.S. debt levels, it appears in the short-term that the ship is pointed in the right direction and the fresh infusion of stimulus should be a tailwind for the economy.
In the bond market, the primary reason for weakness is due to the sharp rise in U.S. treasury rates, especially at the long end of the yield curve.
The 2-year U.S. treasury rate, which tends to be much more correlated to the Fed Funds rate, has stayed consistent at 0.12% since the onset of 2021 and ended the quarter at 0.16%. Long-term interest rates have risen swiftly with the yield on the 10-year treasury bond climbing from 0.91% to 1.75% at the end of the quarter. Longer dated treasuries tend to be driven by expectations of economic growth and inflation and the sentiment on each has been rising this year. When rates increase existing bond prices fall with longer maturity bonds suffering the most. Coral Gables Trust has maintained a shorter duration posture than the primary fixed income indices, so we believe we are well insulated from further increases in rates. Our Investment Committee will continue to monitor interest rates as they are a key driver for markets. If rates continue to rise in a rapid fashion, they will have a negative effect on the markets as inflation concerns rise and the competitive landscape between equities and fixed income intensifies. Foreign bonds were down -3.42% for the quarter, while the performance of the Barclays Aggregate Bond Index was slightly better for the quarter with a -3.37% return.
After a decade of U.S. stocks outpacing their international peers, we are beginning to see better performance results from foreign equities. Given the relative valuation advantage abroad compared to the U.S., international exposure remains an important component within a diversified portfolio. The weakening of the dollar over the last several quarters has also provided a benefit to U.S. investors utilizing foreign investments. In the quarter, international markets slightly underperformed the U.S. The MSCI ACWI ex US index returned +4.57% for the quarter and the MSCI EAFE index returned +3.48% for the quarter.
THOUGHTS ON ASSET ALLOCATION
During the past decade we have seen value transitions occur in short bursts followed with growth stocks rebounding to continue their outperformance. This trend towards fundamentally valued companies has not only started to reduce the record performance gap between growth and value but is setting the stage for increased market breadth. Our equity allocations have ample exposure to both growth and value, and we believe we are appropriately positioned for either direction the market decides to take. Historically, a diversified approach to both growth and value has achieved optimal long-term risk-adjusted returns and reduces the risk of ill-timed tactical adjustments.
Regardless of the market environment, our best-in-breed managers focus on high quality fundamentals and downside protection. Our equity managers are off to a fantastic start in 2021 with most of the results ahead of their benchmarks. Listed below is a subset of our equity and fixed income managers that performed exceptionally well versus their stated benchmarks in the first quarter.
We look forward to speaking with all of you regarding our views and the performance of your respective portfolios. For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214 or Michael Unger, Investment Officer, at 786-292-0310