April 2021 Newsletter to Clients

Enjoy this month’s edition that features a review of the first quarter stock and bond performance plus a summary of insights from JP Morgan.

The Federal Reserve is predicting the U.S. economy will grow 6.5% during 2021 – the highest rate since the mid-1980’s. Meanwhile the first quarter was very good for stocks:

• S&P 500 gained 5.8%;
• The NASDAQ index of mainly technology stocks returned 2.8%;
• The small company Russell 2000 Index returned a whopping 12%.

Meanwhile, the yield on the 10-year U.S. Treasury bond – in effect, the risk-free rate for all investments – almost doubled to 1.74%. When bond yields increase, the prices of bonds decrease but, overall, the rise in rates means investors have more optimism about the general direction of the economy.

So, what does that tell us about future stock and bond returns. For some insight, here are some highlights of a JP Morgan market update:

U.S. Stocks:

• The Price/Earnings ratio is 21.88 for the 500 largest U.S. companies (meaning we pay almost $22 for $1 of company earnings with this group of stocks)
  • The 25-year average is 16.64
• The CAPE ratio (essentially the P/E ratio from above but using average earnings over the last decade) is currently 35.91;
  • The 25-year average is 27.57
• Furthermore, the largest 10 companies of those 500 (think Apple, Amazon, Facebook, etc.) has a combined P/E ratio of 30.1 while the remaining 490 companies’ P/E ratio is just 19.6.

Bonds:

• The Bloomberg Barclays Aggregate Bond Index - the index most widely used for investment-grade bonds – lost 3.28% during the first quarter;
• For historical context, the worst year in the last 45 was a loss of 2.92% in 1994.

What’s Next:

JP Morgan says one of the best predictors of future stock returns is to flip the Price/Earnings ratio to make it the Earnings/Price ratio. If we flip the current ratio, we get 1/21.88, or 4.5%. Using this measure, a return of 4.5% for large, U.S. stocks over the next few years is to be expected.

For bonds, we can estimate future returns by using the current 10-year U.S. Treasury yield of about 1.74%.

Taken together, if these predictions come to pass, one can expect returns over the next few years to be considerably less than what we’ve experienced the last 2 years.

What to do:

According to JP Morgan, “Given the uncertainties investors continue to face, it would be wise to maintain a somewhat defensive and diversified stance…”

So, Moneywatch will continue to focus on two areas to help our clients achieve their own, individual goals:

1. Diversify each client’s portfolio through a mix of asset classes such as cash, bonds, large and small U.S. stocks, real estate stocks and international stocks. International companies, in particular, are cheap relative to U.S. stocks so we will continue to ensure exposure there.
2. We will continue to rebalance clients’ portfolios quarterly in order to keep your investment strategy where we think is best for you. So, if stocks rise, we will pare some of those profits and purchase funds in other asset classes. Conversely, if stocks fall, we will pare some other asset classes and take this opportunity to purchase stock mutual funds at more attractive prices.

Thank you for your continuing confidence.