Investment Commentary, Research and Thought Leadership

Q1 2021

Q1 2021

Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist

+51%, +18%, +93%, +135%, -44%, +68%, -31%, -60%, +3%, -42%, +19%.  These were the daily returns in GameStop (GME) stock in a wild two weeks from January 22 to February 5 that saw Reddit, Robinhood, and Roaring Kitty dominate market news.  While the re-emergence of Value might have been notable to industry insiders, the gamification of the US equity market captured the interest of the broader public.  Fundamental analysis seemed like a quaint notion in a market where a lightly organized group of people could turn a $1 billion market cap money-losing company into a $24 billion market cap money-losing company in a matter of days.  While things appear to have settled down by the end of the quarter, one can wonder whether something about the markets has changed.  Time will tell.  Oh, and 10Y US Treasury yields ONLY doubled.

Supported by an improving macroeconomic outlook, the Russell 3000 Index finished the quarter with a return of +6.4% as value and smaller capitalization companies led the way.  Large cap stock returns were still respectable as the Russell 1000 Index returned +5.9%.  However, following their best quarterly gain ever in Q4, small cap stocks continued to lead with the Russell 2000 Index returning +12.7%.  Returns in international markets were more modest as a bout of dollar strength (+3.7% for the USD index) and less favorable pandemic trends weighed on results.  The developed market MSCI World ex USA Index returned +4.0% while the developing market MSCI Emerging Markets Index returned +2.3%.  A significant jump in US 10Y yields hurt fixed income returns, but higher yielding credit was a relative outperformer.  The Bloomberg Barclays US Aggregate Index returned -3.4% while the Corporate High Yield Aggregate returned +0.9%.  Performance in non-US fixed income was more challenged as the Global Aggregate ex-US Index returned -5.3% and the JPM EM Bond Index returned -4.5%.

At the Sector level in US equities, the rally continued to be led by the cyclical sectors of Energy (+31.5%), Financials (+16.4%), Industrials (+11.3%), and Materials (+17.4%).  Once again, every sector posted positive returns for the quarter as investor sentiment improved on stronger macroeconomic data and optimism regarding the management of the pandemic.  With the rotation, the laggards were pandemic beneficiaries like Technology (+1.5%), Consumer Staples (+2.1%), and Health Care (+2.5%).  A similar story took hold outside of the US with Energy (+9.5%) and Financials (+8.5%) also leading.  The main detractors were Health Care (-4.0%) and Consumer Staples (-1.9%).

In a mixed quarter for country returns, the range went from -17% to +16%.  A set of smaller markets led performance with Saudi Arabia (+15.8), Chile (+15.5%), and UAE (+13.7%) among a group of six countries posting greater than 10% returns.  Colombia (-17.1%), Turkey (-15.5%), and Peru (-10.4%) were the main laggards.  Among the major markets, the United Kingdom (+6.4%) outperformed while Japan (+1.9%) and China (+0.2%) underperformed.

Given the significant upward movement in interest rates, all of the main sectors within core US fixed income markets were negative, but performance was weakest in Corporate Investment Grade (-4.7%) and Treasuries (-4.3%).  The securitized sectors of ABS (-0.2%), MBS (-1.1%), and CMBS (-2.3%) were only incrementally better.  Outside of the core sectors, US High Yield (+0.9%) and Leveraged Loans (+1.8%) were able to post positive returns while Municipals (-0.4%) and Inflation-Linked Treasuries (-2.0%) were negative but outperformed.  Emerging market debt saw highly divergent returns as the Government sector (-6.7%) meaningfully underperformed Corporates (-0.8%).

Overall market volatility was higher than historical averages with January and February seeing significant increases in the VIX.  Trade volumes were also higher than average, as the meme-stock rally epitomized by GameStop likely drew in a large number of retail investors.  Market breadth was generally positive.  At the factor level, Value was dramatically positive, continuing a recovery started in September of last year.  Smaller Size and Yield were also highly additive exposures.  Stability was again dramatically negative as the quarter continued to favor cyclical recovery plays, and this ongoing reversion led to negative results in Momentum and Quality. With the move of market leadership away from mega cap growth, equal-weighted portfolios meaningfully outperformed market cap-weighted portfolios.