April 14, 2021
Princeton Global First Quarter 2021 Investor Letter
Global equity markets remained in an uptrend during the first quarter of 2021. Overall, stocks that stand to benefit from the re-opening of the global economy were market leaders, outperforming the shares of companies that were the beneficiaries of the COVID-19 pandemic. Notably, the Energy, Financials, and Industrials sectors outperformed the Technology sector and traditional “defensive” sectors. Indicative of the outperformance of re-opening related equities, the S&P 500 Value Index’s total return was 10.8% during the first quarter of 2021 versus a return of 2.1% for the S&P Growth Index. The U.S. equity market’s sustained outperformance over the past decade extended into the first quarter of 2021:
Recent data indicates that the U.S. economy has already entered a strong recovery phase, with China also performing well while Europe, Japan, and other emerging markets are laggards. The differential reflects the U.S.’s success in accelerating the distribution of vaccines for the COVID-19 virus, in contrast to the European Union’s problems. Indications of a more robust U.S. economy are reflected in the March payroll report over 900K increase in employment (most in 7 months) and March Institute for Supply Management (ISM) surveys of factory and services, both exceeded the 60 level (50 or higher indicates expansion).
ISM Manufacturing PMI reached a multi-decade high in March:
In addition to the accelerating pace of vaccinations in the U.S., the impact of a highly accommodative monetary policy by the Federal Reserve and stimulus programs of $900 billion and $1.9 trillion enacted since late last year are having a positive impact on the U.S. economy. Further stimulus is likely, although likely less than the $2 trillion initially proposed by the Biden administration, with the focus expected to be on infrastructure and spread over many years. On Sunday, Federal Reserve Chairman Jerome Powell said on 60 Minutes, “The Fed will do everything we can to support the economy for as long as it takes to complete the recovery.”
For the remainder of this year, our expectation is U.S. economic growth will continue to exceed the pace of much of the rest of the world. This growth will likely be reflected in corporate earnings exceeding consensus estimates, providing a catalyst for higher share prices. As an indication, the International Monetary Fund is now forecasting GDP growth of 6.4% for the U.S. for 2021—as late as January, the IMF was looking for only 1.3% growth.
S&P 500 earnings for 2021 & 2022 have consistently trended higher from last summer. We expect another strong earnings season for the 1st quarter of 2021 and earnings growth to exceed 25% for 2021:
A crucial question is whether the pace of economic growth and the unprecedented level of monetary and fiscal stimulus will lead to a severe inflation problem like the 1970s and early 1980s. The re-opening of the global economy will inevitably lead to higher inflation rates and overshoot the Fed’s 2% target. Producers are citing significant jumps in materials costs due to pandemic-related supply chain disruptions coinciding with pent-up household demand for products and services. Our more extensive internal debate is “after the initial spike, will the overall rate of inflation subside?” Our current belief is that several factors will reduce the potential for exceptionally high rates of inflation, and the long-term trend will remain under control:
• The absence of an oil price shock. Oil increased from $3 to $10 per barrel between 1970 and 1974 and $10 to $39 by 1980. This increase was the primary cause of The Consumer Price Index in the U.S. rising by 8% or more for several years in the 1970s and 1980s.
• An older global population, reducing the propensity to spend.
• Globalization and resultant competition also reduce the ability of companies to increase prices.
• Technology is called the great “engine of deflation.” The pandemic has accelerated technological innovation, enhancing the potential for increased productivity in future years. With increased productivity, wages will have less potential to increase overall inflation.
We anticipate short-term inflation to be volatile and “renormalize” the 30-year downward trend:
JPMorgan’s Jamie Dimon well summarized the current environment in his annual shareholder letter, “the U.S. economy will likely boom…this boom could easily run into 2023“. An economic boom should have favorable implications for corporate earnings and share prices. Of course, there are risks. We are closely watching the developments on proposed tax reform (which could potentially more than offset the benefits of infrastructure spending), risks to our benign inflation view, higher interest rates (especially the impact on growth stocks), and investor speculation and overconfidence. Individual investors are the least bearish since the market rallies in April 2019 & December 2019. Historically, confidence extremes have been contrarian indicators:
We have maintained diversified portfolios and continue to analyze companies benefiting from the economic re-opening and have solid long-term growth prospects. Recent additions include stocks in the Consumer Discretionary, Industrials, and Materials sectors, where we anticipate a sharp rebound in earnings growth for the remainder of 2021. Our portfolio changes in the last several quarters have been “evolutionary vs. revolutionary.” The primary reason is the stellar fundamentals and cash flow growth of many “big-growers” in the Technology, Communications, and Healthcare sectors. We continue to focus on quality and profitability, avoid the most speculative areas of the market, and prefer to watch events like the Reddit Stocks momentum and the Archegos Capital unwind from the sidelines.
A multitude of data indicates pent-up consumer demand for travel and leisure activities after months of quarantine. We are looking to find stocks in related industries that have reasonable expectations.
We entered 2021 looking to add international developed market stocks over U.S. stocks. Valuations of international stocks remain compelling. However, significant risks remain across many international countries’ economies due to virus variants and less robust vaccination programs. Once Europe and Japan can match the U.S. in the pace of vaccinations (late 2021/2022), their economies should also begin a period of sustained recovery. Despite the near-term uncertainty, we continue to see an attractive long-term outlook for Emerging Market equities and maintain positions weighted towards China and Taiwan.
Our investment strategies had a solid beginning to the year. Dividend Growth benefited as classic dividend investing returned to favor (cyclical industries rebounded), and the strategy’s growth-orientated investments continue to appreciate. We continue to believe a dividend growth investing approach is well-positioned for the current environment of low and rising interest rates, and we are incorporating across all our strategies.
The Health Care, Consumer, Technology, and Industrial sectors are expected to have above-market dividend growth in 2021 and are aligned with overweights of the strategy:
Our Global Equity strategy has performed well to start 2021 led by the overweight to the Financials sector, which we have highlighted as one of our favorite pro-cyclical sectors going forward. Technology remains a key sector for outperformance led by several of our largest Semiconductor, Software & Internet holdings.
Our managed Exchange Traded Fund portfolios have been well-positioned for the economic re-opening with equity exposure tilted towards Dividend Growth, Quality, and Mid-Cap fund styles. We maintain a “barbell” in fixed income holdings, combing Preferred Stock funds with short-duration investment-grade funds.
Fixed Income Strategy
U.S. interest rates outside of the shorter maturities exhibited a substantial increase during the first quarter, responding to the re-opening of the U.S. economy. The first quarter return for Treasuries was the worst for any quarter since the early 1980s. While the yield on 2-year Treasury obligations increased only four basis points, from 0.12% to 0.16%, the yield on 5-year Treasuries increased from 0.35% to 0.92%, and 10-year yields increased from 0.91% to 1.74%. The dramatic expansion in the gap between short- and longer-term fixed income securities reflects the re-opening of the U.S. economy as the pace of vaccinations accelerates and the impact of highly stimulative monetary and fiscal policy positive impact on the pace of growth.
Our expectation is for further increases in intermediate and longer-term interest rates in the coming quarters. However, our expectation that inflation will remain subdued by historic standards will tend to limit the extent of a further interest rate rise. We point out that the current level of interest rates remains low by historical standards so that a modest further increase need not be disruptive to economic growth. With this outlook in mind, we continue to maintain a short duration in our taxable and tax-exempt fixed income portfolios and look for opportunities to extend maturities on a selective basis in coming quarters.
The 10-year Treasury yield increased rapidly during the 1st quarter but remains well below historical levels. We are watching the 2.0% level:
Princeton Global Asset Management, LLC