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Commentary

Q1 2021 Markets Summary: A Change in Leadership Across Stock and Bond Markets

Struggling investment classes and sectors turned in strong performances with hopes for progress against COVID-19.

One theme dominated market trends in the first quarter - just as it did in Washington D.C.: a change in leadership.

With hopes for progress against COVID-19 leading to optimism about the economic rebound, struggling investment classes and sectors turned in strong performances. At the same time, the corners of the markets that had been hot - in some cases for years - turned cold. 

Laggard value stocks leapt to the lead, richly valued growth stocks faded, energy stocks bested all other sectors, and technology stocks landed in the unusual position of worst performers. Smaller companies more likely to have their fortunes tied to the strength of the U.S. economy were among the best performers. Dividend-payers, which struggled in 2020, also saw a first-quarter recovery.

In the bond market, dormant expectations for inflation began to emerge, leading to losses across interest-rate-sensitive sectors of the market even as the Federal Reserve committed itself to easy-money policies. (Our full quarterly markets wrap can be found here.)

On an overall basis, the first quarter’s stock market returns were solid but not dramatic. The Morningstar U.S. Market Index gained 6% during the quarter, hitting a new high on March 15.

However, on a year-over-year basis, a more compelling story emerges as the scope of the bounceback from the depth of last year’s brutal bear market becomes clear. From where it ended in the first quarter of 2020, the Morningstar U.S. Market Index finished this month up 61%.

Meanwhile, under the hood of the stock market, there were significant changes in leadership. Perhaps most notable was strength in value stocks, which have been lagging significantly in recent years. Still, the longer-term performance gaps in favor of growth stocks remains wide.

The broadening out of the recovery and rising interest rates boosted cyclical stock sectors during the quarter. Energy stocks gained 31%, and financial services and basic materials companies led all other sectors.

Defensive sectors suffered and tech stocks gained the least of any sector for the first time since 2016.

The first-quarter bond sell-off hit Treasuries the hardest, followed by safer core and corporate bonds. Only high-yield bonds managed to end the quarter in positive territory.

In the background, the yield curve steepened severely from three months ago on expectations for stronger economic growth. The 10-year yield has risen by 1.04 points since last year, reaching pre-pandemic levels near the end of the first quarter.