What a crazy twelve months it has been in the stock market. Small-cap stocks as represented by the Russell 2000 are up 94.85%. Large-cap stocks (S&P 500) are up 56.35% while bonds are up 0.71%. Let these returns be “Exhibit A” on how difficult it is to try to time the stock market. Looking back at my March 31, 2020 quarter-end letter, we did not know if it was going to be a “U” or a “V” shaped recovery, but it could have easily been a “W” or “L” shaped recovery as investors could have bet on a huge COVID surge over the winter. As the presidential election uncertainties became more certain and the news of successful vaccines became headlines, investors bid up the stock market thinking an economic recovery was going to be here sooner than anyone would have imagined back in March of 2020. If a 56.35% recovery in the S&P 500 from the March 31 bottom isn’t a “V” shaped stock market recovery, I don’t know what is.
So the near-term stock outlook becomes fuzzy after the S&P 500 returned 6.17% in the first quarter and an additional +4% so far this month. In the year-end letter, I mentioned one of the most optimistic S&P 500 year-end targets was 4,300 by Ed Yardeni. As I write this, we are only 3.8% away from that level. As more and more people receive the vaccine and re-enter the workforce and the government spending increases at the individual, corporate and government levels, the economy will certainly try to catch-up with the stock market rocket that took off at the end of March 2020. Let us hope for some better corporate earnings numbers in the months ahead. If we do not receive better earnings, we could end up with some volatility this summer and fall.
The Plan: With the market rally this year, is the stock market ahead of itself? Possibly. Our plan is to stick with your existing equity-to-fixed income allocation going into the summer. As I have said before, no one knows how the stock market will perform from one month to the next. Looking at a longer-term perspective, I believe stocks will do better than bonds over the next ten years as bonds are expected to only return around 1-2% per year. With the increase in government spending and the loose Federal Reserve policy, inflation will most likely rise and those 1-2% returns from bonds could quickly be lost to inflation. One strategy I am considering is to increase your stock allocation by about 5 or possibly 10%. Corporations are somewhat shielded from inflation in that they can pass the increase in the cost of their goods and services on to their customers where most bonds do not have an inflation component. Rather than invest in high yield or junk bonds to take advantage of higher yields, I would prefer to keep our fixed income in high quality bonds. Thus, if you are concerned about inflation overtaking your fixed income return, we should consider increasing your stock allocation by 5-10%. Please contact us if you are interested in increasing your equity allocation.
As you peruse your quarter-end reports, I would like you to focus on a few of your holdings. The very securities I wrote about three months ago as underperforming in the year 2020 are beginning to make up for lost time this year. The PRIMECAP funds, which held airlines through the thick and thin - more emphasis on the thin - of it last year, are one of our better performers this year. Berkshire Hathaway, which has a large underperforming financial stake, and Oakmark International, which has several underperforming European banks and European car manufacturers, are all up nicely so far this year. So we know that timing does not pay, but patience does. Enjoy spring and stay safe!