Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist
Just as the proponents of value and smaller cap stocks were preparing their “I told you so’s, the market decided to shift back to where it had been for so long – led by US mega cap Technology names. While other stocks had the honor of leading in returns (AMC and its +455%), Technology names (including Amazon) were nine of the top ten contributors to the S&P 500 Index’s return. In the markets, there seemed to be a sanguine interpretation to almost every potential concern. Inflation re-emerging? It’s transitory, and you’d want to be in stocks anyhow to get your growth. Economic performance softening? That just means the Fed will continue keeping the proverbial punchbowl stocked. COVID still raging? It’s more of a local story now and look at how many places are re-opening. As new market highs are approached, one has to wonder just how much better things can really get and how much of those better things are already priced in. Irrational? Tell that to the AMC shorts.
For a fifth straight quarter, the broad markets posted positive returns. The Russell 3000 Index finished the quarter with a return of +8.2% as growth and larger capitalization companies returned to leadership. Large cap stock returns accounted for most of the gain as the Russell 1000 Index returned +8.5%. However, small cap stocks continued to post positive results with the Russell 2000 Index returning +4.3%. Returns in international markets were good but modestly lagged those of the US. The developed market MSCI World ex USA Index returned +5.7% while the developing market MSCI Emerging Markets Index returned +5.1%. US 10Y yields retraced some of the dramatic gain of the prior quarter helping fixed income markets recover some of their YTD losses. The Bloomberg Barclays US Aggregate Index returned +1.8%, and the Corporate High Yield Aggregate returned +2.7%. Performance in non-US fixed income was comparable as the Global Aggregate ex-US Index returned +0.9% and the JPM EM Bond Index returned +4.1%.
At the Sector level in US equities, while “Value” sectors like Energy (+12.3%) and Real Estate (+11.4%) led, the “Growth” sectors of Technology (+11.3%) and Communication Services (+11.1%) were close behind. Every sector outside of Utilities (-0.6%) posted positive returns for the quarter as continued accommodation by the Fed and progress on economic re-opening supported investor sentiment. With the reversal, the other laggards were Consumer Staples (+3.4%) and Industrials (+3.8%). A slightly different story played out outside of the US with Health Care (+10.2%), Energy (+9.5%), and Consumer Staples (+7.1%) leading. The main detractors were Utilities (+0.6%), Communication Services (+2.0%), and Financials (-4.4%)
While there was a normal mix of returns amongst the various local markets, the skew was positive with a range of +24% to -13%. Topping the count from last quarter, Brazil (+23.6%), Poland (+19.2%), and Hungary (+14.6%) were among a group of thirteen countries posting greater than 10% returns. Chile (-13.2%) and Peru (-9.1%) were the main laggards as political wrangling weighed on those markets. Among the major markets, Japan (-0.2%), the United Kingdom (+5.7%), and China (+3.2%) all underperformed to various degrees. The trade-weighted US dollar index declined 0.9%.
With the decline in interest rates, all of the main sectors within core US fixed income markets were positive with Corporate Investment Grade (+3.6%) leading the way. Treasuries (+1.8%) also posted a respectable return while the securitized sectors of CMBS (+1.9%), ABS (+0.3%), and MBS (+0.3%) were mixed. Outside of the core sectors, US High Yield (+2.8%) and Leveraged Loans (+1.5%) added to their YTD performance while Municipals (+1.4%) and Inflation-Linked Treasuries (+3.7%) recovered from prior quarter weakness. Emerging market debt saw a reversal of the dynamics of the prior quarter as the Government sector (+3.5%) outperformed Corporates (+2.1%).
With some of the fervor around meme stocks and retail trading settling down, overall market volatility declined towards pre-pandemic levels. Trading volume remained higher than average, with the rally in AMC energizing a segment of retail investors. Market breadth was generally positive but tapered off towards the end of the quarter. At the factor level, the recent turn towards Value and Smaller Size appeared short-lived with both factors showing meaningful underperformance. Yield was also negative. Quality and Momentum returned to favor, and Stability was modestly positive. With the move of market leadership back towards mega cap growth, equal-weighted portfolios underperformed market cap-weighted portfolios.