---

The US equity market has carried its fourth quarter 2020 momentum right into 2021 with a continued surge in small cap domestic equities, commodities, and emerging market equities overseas. Below you will see just how strongly these diversifying asset classes have performed during the first two months of the year.

Since the bear market drawdown end on March 23, 2020, the S&P 500 has risen 70% – with dividends reinvested – even as the pandemic raged on, many COVID-19 sensitive sectors continued to struggle, and concerns over the size of the budget deficits and national debt grow. The rising asset prices have many concerned about the above average valuations.
Regardless of how you choose the measure equity valuations, they are well above historical averages. The chart below lists 5 different valuation metrics and each of them suggests we are more than 2 standard deviations above historical averages.

The Price-to-Earnings ratio is one of the most commonly used valuation metrics and so far in 2021, the earnings denominator has been very supportive of current asset prices. Earnings ultimately drive long-term market results and, as you can see below, corporate earnings adjustments have been moving higher after their anticipated 2020 drawdown. Corporations have boosted profitability by cutting costs, financing themselves with low interest rates, and increasing efficiency.

Investors are always tasked with determining where to allocate new money and one of the primary asset allocation decisions is whether stocks are more favorable than bonds over a particular time horizon. The competition for investor dollars between stocks and bonds is often made by evaluating the yield curve. The Federal Reserve has indicated short-term yields will remain low for another couple years as the economy recovers and employment levels return closer to pre-COVID levels. Recent movements higher in the longer end of the yield curve tell us that investors are demanding higher government bond yields to not only compete with dividend yields of the equity market, but also keep up with inflation.

A steeper yield curve would be challenging for fixed income total returns, but guessing where interest rates are headed are about as unpredictable as timing the equity markets. So let’s start with what we know about two areas that have historically impacted bond yields: the economy and budget deficits. Consumer spending accounts for nearly 70% of economic growth and this economic recovery is featuring very strong retail sales and e-commerce activity. A strong recovery in the labor market could add fuel to the spending spree.

Historically low interest rates have had a big impact on the housing market as well – further supporting economic development.

We also know that the US government has taken advantage of low interest rates by borrowing trillions of dollars and continuing to run up the national debt. The government posted over a $3 trillion dollar deficit for the fiscal year end September 30, 2020, which equated to 15% of GDP.

The economy and capital markets are producing positive results in a post pandemic world relying on activity returning closer to “normal.” Yet they will continue to seek equilibrium as the economy accelerates, Congress provides relief and inflation ticks higher. It was an uneven economic and equity market rebound as the pandemic spread and it will be an uneven evolution as the pandemic wanes. Diversification aided portfolios in 2020 and is supporting results so far in 2021.

---

Important Disclosures:
The information given herein is taken from sources that IFP Advisors, LLC, dba Independent Financial Partners (“IFP”), IFP Securities LLC, dba Independent Financial Partners, and its advisors believe to be reliable, but it is not guaranteed by us as to accuracy or completeness. This is for informational purposes only and in no event should be construed as an offer to sell or solicitation of an offer to buy any securities or products. Opinions expressed are subject to change without notice and do not consider the particular investment objectives, financial situation, or needs of individual investors. Past performance is no guarantee of future returns. Investors cannot invest directly in an index. Diversification and asset allocation do not guarantee returns or protect against losses.