In the first quarter of 2021, the US economy gained 6.4 percent on an annualized basis, on to strong consumer spending buoyed by federal Covid-relief payments. Despite being slightly lower than expected, this was the strongest growth rate in decades. The US GDP is expected to recover to pre-pandemic levels in the second quarter.
Investors expected good earnings in Q1 2021 compared to the epidemic lows last year, and the results have exceeded expectations thus far. According to Fact set, with 60% of S&P 500 businesses reporting, 86% have reported favorable earnings surprises. Given this context, US equities have continued to rise.
Emerging markets (EM) increased but lagged behind the US. While developed countries make success against Covid-19, several key emerging markets are struggling. Nonetheless, despite soaring infection rates, certain EM markets, such as India (+2.3 percent) and Brazil (+4.3 percent), were up in April, as investors anticipate foreign help and economic resilience.
The 10-year US Treasury yield settled in April between 1.6 percent and 1.7 percent after a spectacular climb during March, with the Fed insisting that inflation is well-controlled despite consumer prices rising 2.3 percent year on year. Strong incoming industrial and labor market data may re-ignite the trend toward higher yields.
Commodities rose in April as economic activity picked up. While oil returned about 7.5 percent throughout the month, industrial commodities such as copper (+12.3 percent) outperformed. Shortages in the midst of a homebuilding boom have resulted in a huge increase in the price of finished lumber, which was up nearly 50% in April alone.
Merger and acquisition activity has accelerated to its greatest level in history, as firms wealthy with cash and private equity funds flush with "dry powder" seek investment opportunities. Given low borrowing rates and prospective corporate and investment tax rises to incentivize sellers, the trend is expected to continue.
So far, everything is going swimmingly. The pace of economic growth in the United States appears to be picking up, as expected. Our base scenario is that above-trend growth will be driven by increased consumer spending, which accounts for approximately 70% of US GDP. Consumer confidence reached 121.7 in April, the highest level in 14 years, while spending climbed 10.7 percent in the first quarter, despite weakening in other components of GDP such as exports. Continued labor-market recovery, as well as ongoing federal government support (unspent Covid-relief, pending infrastructure legislation), will give more fuel. With approximately 60% of the US population having already gotten at least one Covid-19 vaccine dose, we are well on our approach to achieving a 70% full-vaccination rate by this summer.
At this stage, investors' primary attention is on inflation and the extent to which interest rates climb. We believe inflation will accelerate from here and rates will rise further, but the amount of both changes is uncertain, and neither data point is assured to reach a troublesome range.
We believe, as does the Fed, that increasing inflation will be primarily transitory, with only minor upward pressure on interest rates in the short future. Given that inflationary pressures have only lately begun to rise, this notion will be put to the test in the coming months.
Potential tax rises are another risk to the financial markets, according to us. While more government spending is likely to have a beneficial short-term impact, we are closely monitoring Congressional debate on raising the corporation tax rate, personal tax rate, and capital gains tax to pay for new federal programs. Increased corporation taxes would reduce profits, whereas individual rates are an important factor in how we arrange portfolios for our clients.
We are glad to see that the asset classes and sectors we predicted would outperform in 2021 have done so, with stocks significantly outperforming fixed income. Given the economic recovery, we believe cyclical stocks are the most promising among equities.
Despite the recent increase of Covid cases in important emerging economies, we believe this space is worth investing in given the longer-term development potential and the probability of support from rich countries via excess vaccine supplies. While we always keep some inflation-sensitive exposure to commodities and other real assets, we are assessing that position to be better prepared if inflation accelerates faster and for a longer period of time than we anticipate.