Summary of 1Q/2021: Small and Value Prevail Again
It has been a little over a year since the market hit its pandemic bottom last March, and the first quarter saw a continuation of the market’s robust gains. As with the prior quarter, value beat growth and small beat large. Recall that U.S. Large Growth (composed largely of information technology companies) was the dominant asset class in the 2010s decade and 2020. Make no mistake, small cap and value stocks still have a long way to go before they catch up with the spectacular returns of large growth. Recent performance has reminded us that far-above-average returns are not sustainable in perpetuity, as there will always eventually be a reversion to the mean which the great John Bogle referred to as the market’s own law of gravity. There is certainly less chatter in the financial media regarding a new paradigm where networking effects accrue to the benefit of the mega tech companies at the expense of all others.
The quarter was chock full of important events, starting with the transition to a single party in charge of the House, Senate, and White House. In short order, they passed another $1.9 trillion of COVID stimulus spending. The vaccination rollout is well underway, but we just learned of a setback for Johnson & Johnson which had to discard 15 million doses due to human error. We are watching the ever-increasing number of variants of the SARS-CoV-2 virus, but the market does not seem concerned.
We witnessed the rise of the meme stocks (e.g., GameStop) fueled by Reddit users who, like the rest of us, can now trade stocks without commissions. As some of them learned, however, commission-free does not equate to cost-free. The newbies who receive their education from Mr. Market can expect to pay a high tuition. Other speculators have become enthralled with SPACs aka “blank check companies”, and of course, there is still Bitcoin which doubled yet again during the quarter. If this rate were to continue, it would take less than two years for the value of all Bitcoins (including the 2.5 million that have yet to be mined) to dwarf the value of all other financial assets combined. In fairness, cryptocurrencies have gained much wider acceptance as a method of payment with the endorsement of both governments and corporations.
The table below summarizes the estimated returns for various asset classes based on the performance of Vanguard index funds. Please note that they do not necessarily represent the returns of the funds or portfolios utilized by Clarity Capital Advisors.
Asset Class Ticker Used 1Q/2021 Return
US Total Market VTSAX 6.4%
US Large Growth VIGAX 1.5%
US Large Value VVIAX 11.0%
US Small Growth VSGAX 2.6%
US Small Value VSIAX 16.8%
International VTMGX 4.0%
Emerging Markets VEMAX 3.6%
US Real Estate VGSLX 8.7%
Int’l Real Estate VGRLX 2.6%
US Bond Market VBTLX -3.6%
US TIPS VAIPX -1.4%
As seen above, all the classes of stocks had gains while bonds suffered losses. When we say that bonds act as a diversifier against stocks, we mean that you should expect to see quarters where they move in opposite directions. The loss for bonds is explained by the increase in longer term interest rates, largely attributable to the market’s expectation of higher inflation induced by massive government spending and extremely accommodative monetary policy. Inflation-protected bonds (TIPS) experienced a smaller loss because their yields increased by a lower amount than the increase in regular Treasury yields. The bond market’s expectation of inflation over the next decade increased from 2.0% to 2.4%. Although we have seen inflation in real estate prices (especially suburban houses) and fuel prices along with other commodities, the more general gauges like the Consumer Price Index are not yet flashing red. Held back by a strengthening dollar, the returns of foreign equities and real estate were lower than their U.S. counterparts.
The recurring theme of this quarter appears to be a rise in speculation. As tempting as it may be to throw caution to the wind and join the crowd, we would advise against it (no surprise there). At the risk of being labeled as dull, we recommend sticking with assets that have an explainable positive expected return—stocks, bonds, and real estate. And to make ourselves even more boring, we will say it again: Our advice is to be invested and stay invested at an appropriate risk level, and by appropriate, we mean an asset allocation to meet your goals that you will hold through all different types of markets.