Introduction

The coronavirus vaccine rollout began worldwide. The U.S. rollout has been particularly successful at the onset, already reaching over 28% of the population, while most other major economies are still far behind. Nonetheless, vaccine programs are a global positive because they have given line of sight to the economic reopening and recovery. The biggest question now pertains to the timing.

Because of this, expectations for a more powerful global recovery have materialized. And through it all, investors had the reassurance from the Federal Reserve (Fed) that it would continue to hold interest rates near zero, and that the U.S. government would deploy trillions of dollars more in aid to boost the economy.

Financial markets responded in force. Long-term bond yields climbed in anticipation of higher economic growth and inflation, which therefore pushed discount rates higher. In one of the most severe equity market rotations in years, shares of technology and other growth stocks were battered, while shares of beaten down sectors and value stocks rose significantly.

In this environment, portfolios still appreciated in value, but we underperformed relative to our benchmarks. We made several adjustments prior to the wholesale growth-to-value rotation, which began in mid-February, to reduce holdings with extended valuations and increase holdings that were more attractively priced or should be cyclical beneficiaries, but the adjustments were not enough. As the rotation continued through the remainder of the quarter, some holdings were disproportionately hit, and we took advantage of these dislocations to selectively add to holdings and also initiate a new position in a company we have long coveted.

Market Update

The U.S. was at the center of both economic developments and market developments in the first quarter. Among the highlights were a successful vaccine rollout, a new tranche of pandemic fiscal stimulus, reassurances of continued easy monetary policies, and green shoots of its own economic recovery.

These same factors, however, drove bond investors to push treasury yields higher in anticipation of economic growth and inflation heating up. The benchmark 10-year treasury yield finished the quarter at 1.74%, which is still low by historical standards but is much higher than the record low of 0.52% reached last August or where it started this year at 0.92%.

The rise in treasury yields rippled through to all financial assets. For stocks, rising yields are a mixed bag. It has arrested the rally in technology and other growth stocks as the value of long-term cash flows have eroded due to a higher discount rate. Conversely, it has lifted financials and accelerated the rotation into other beaten down sectors that may enjoy a cyclical rebound from the economic reopening. Changes in growth forecasts and the discount rate can have large effects on stock valuations, and this explains why stock price performance rotated so violently between growth stocks and value stocks.