It was another good month for the equity markets, with the S&P500’s 4.7% and the growth-oriented NASDAQ 100’s (QQQ) 4.4% gains all occurring in the first two weeks of the month. Small caps (IJR) and Large Value (VLUE) lagged, rising 1.4 and 1.2% respectively. As interest rates stabilize, the bond market bucked its recent downward trend with a gain of more than .5%.
WHAT’S DRIVING THE MARKET
The big focus in April was earnings, which Q1 season kicked off the second week of the month. As expected, year-over-year earnings growth was significant – coming from last year’s low point when the economy was reeling from the unknown effects of the pandemic. Most companies beat expectations, sometimes significantly, which points to the continued repair of corporate America and the economy.
The “stay at home” beneficiaries, such as Apple, Microsoft, Google and Amazon had some of their best quarters in recent memory, confirming that utilization of these digital services was robust. While valuations may be even more stretched, the growth of earnings to the extent we are seeing somewhat justifies the elevated prices, since many of these tech darlings have significant cash on their balance sheet from higher sales of their products and services. This cash can be thought of as a stabilizer to provide support to their stock price, and if earnings growth outpaces price growth, valuations should come down from such lofty levels.
The Federal Reserve concluded its 2-day meeting on 4/28 and continued to support dovish monetary policy, again stating that they will not adjust their interest rate regime until further and continued repair of the economy. So, for now, the punch bowl is still on the table even though the market will continue to wonder how long the current rate accommodations will last.
PORTFOLIO ADJUSTMENTS
There were not a lot of trades this month beyond the first week, but significant changes to the overall allocation occurred as we sold our small cap position and purchased more financials (XLF) and S&P500 (SPLG). We also evacuated our large cap value (VLUE) position, capturing a 20% gain. With the proceeds, we purchased QUAL, a large cap blend factor fund investing in mega cap companies screened for quality attributes such as high return on equity, low debt/equity and stable earnings growth. We are positioned market neutral at this juncture, with approximately two-thirds of equity positions being in the large cap blend space. A 5% position in financials and 5% position in a multi cap value fund, FAB, appropriately balances out the QQQ large cap growth position. Clearly, the sale of small blend and large value to large blend kept more assets in the sweet spot, and capturing a sizable gain from VLUE, which had outperformed the S&P 500 by 970 basis points (9.7%) during our holding period highlights the alpha (outperformance) generating potential from our tactical process.
LOOKING AHEAD
As we enter the month of May, we wanted to reflect on an oft used adage of “sell in May and go away,” which, from a seasonality perspective, reflects that on average, the months between May and October have historically generated lower average returns than the seasonally strong October to April time period. In more recent years, selling in May forfeited productivity, as the summer months have been more generous than average. However, this year we may very well see a sideways or even sagging summer season, if only because the market is up 52% from the March 2020 pandemic low, and already up 12% YTD. We would not be surprised to see the market take a breather in the months ahead, as there is the potential that a lot of the re-opening excitement is already reflected in current asset prices.
We are of the opinion that the market can continue to move higher over time. There is ample money on the sidelines that will likely find its way into the stock market, with: continued improvement in economic activity, committed support from the Fed, a consistently declining unemployment rate, pent up consumer demand and increasing consumer sentiment, income and savings rates, plus historically low interest rates. These tailwinds should help maintain gains for the balance of the year. The one item we are mindfully cautious of is when the Fed eventually will have to pull back on their level of monetary support and fiscal stimulus measures, but the time to worry is still some ways away.
With that being said, we are letting our winners run and maintaining an allocation overweight to our equity targets. We are also diversifying our fixed income allocation away from a traditional vanilla bond position to areas that have more equity like price movement, such as convertibles (CWB) and preferreds (PFF).
Enjoy the month of May, where flowers bloom, the sun shines a little brighter, the school year concludes, and mothers are honored and cherished a little more than any other month!
