Quarterly Market Performance Commentary

A year removed from the beginning of the COVID-19 pandemic, the economic outlook of many investors is finally trending upward. As millions of Americans become vaccinated on a daily basis, restrictions originally set in place to curb the spread of COVID-19 are being lifted and normal business activity is beginning to resume— resulting in accelerated job growth and falling national unemployment rates. Economists are optimistic for a speedy recovery, but market volatility is expected to continue.

In March 2021, Congress passed a third COVID-19 relief bill, the American Rescue Plan Act, that included direct payments to many Americans, additional funding for vaccine efforts, and an extension of the boosted unemployment insurance program, among other initiatives (see figure on right). Fiscal and monetary actions by Congress and the Federal Reserve respectively continue to stimulate the economy.

As quarter one closed, the S&P 500 Index returned +6.17%, with performance driven largely by the Energy and Financial Sectors returning +30.90% and +16.00% respectively. Additionally, the Russell 2000 Index (an index measuring 2,000 small domestic publicly traded companies) returned +12.70%, the MSCI EAFE Index (an index measuring global stocks) returned +3.48%, and the Barclays U.S. Agg. Bond Index (an index measuring the domestic fixed income market) returned –3.37%.

Domestic Equity and Fixed Income

The January domestic equity headlines were centered on the so-called “meme stock” saga (see figure below). Users from the popular online forum Reddit collaborated in driving up stocks like Gamestop and AMC to prices beyond their intrinsic value. The resulting consequence was the necessity for hedge funds who had shorted the meme stocks – or bet against them – to sell their positions at a loss. This was heralded as an afront against the institutional investment elite, and a win for individual investors.  Despite the inherent volatility and artificial inflation this type of trading creates, the domestic indices finished strong in Q1 with the S&P 500 and Dow Jones Industrial Average (DJIA) reaching all-time highs.

In the fixed income market, yields on 10Yr Treasury Notes climbed to 1.74% to close out the quarter – roughly a 91% increase from the start of the year, as investors demand more to make up for expected inflation increases. Yields are typically reflective of investor sentiment of the economic outlook and move in opposition to bond prices. When investors are optimistic, they are less likely to invest in Treasury Notes and more likely to invest in riskier investments like stocks. Additionally, the Federal Reserve voted twice in Q1 to keep the Fed Funds rate between 0.00% and 0.25%, while its balance sheet grew as the central bank continues to buy securities and provide liquidity in the market.

Plan Sponsor Corner

IRS Compliance Initiatives

In early 2021, the Internal Revenue Service (“IRS”) released Publication 5313 (Rev. 9-2020), otherwise known as their Annual Program Letter, designed to provide taxpayers with a summary of their goals and how they plan to achieve them. With regards to retirement plans, the IRS further revealed their examination initiatives, which give plan sponsors insight into what the IRS will look for during plan audits. The IRS plans to focus on the following areas in retirement plans:

  • Participant Loans — Loans will be examined to determine that they comply with IRS rules on maximum amounts and repayment.
  • Partial Plan Termination and Partial Vesting — The ongoing COVID-19 Pandemic forced many employers to layoff or furlough their workforce. The IRS plans to analyze Form 5500 filings and identify plans which had a significant decrease in plan participants. Such plans will be closely monitored to determine if a partial plan termination occurred and if it was handled properly.
  • Worker Classification — Plan coverage of specific employee types will be reviewed, especially misclassification of employees as independent contractors.
  • Small Exempt Organizations that Sponsor Retirement Plans — Typically not in the spotlight, small exempt organizations will be under increased scrutiny to ensure they are properly administered.
  • Required Minimum Distributions (RMDs) — Specific to large defined benefit plans: plan sponsors must begin distributing benefits by April 1 following the calendar year when an employee reaches the required age.
Addressing Missing Participants

On January 12, 2021, the Department of Labor (“DOL”) issued three pieces of guidance on how plan sponsors should handle missing participants. In this release, the DOL details what it views to be important steps plan fiduciaries should take in order to locate and distribute retirement benefits to missing or non-responsive participants. Plan sponsors can first identify missing or non-responsive participants through returned mail/emails, no recent account or phone activity, or outstanding, uncashed distribution checks. The “best practices,” provided under the guidance, to locate these individuals include maintaining accurate census information, implementing effective communication strategies, initiating missing participant searches (checking records, using search engines, etc.), among others. For a list of best practices and how to implement these at your organization, access the following link, which highlights the expanded Missing Participant Program now applicable to defined contribution plans (in addition to pension plans).

DOL Softening ESG Investment Enforcement

In June 2020, the DOL published a proposed ruling that would increase the restrictions surrounding the inclusion of environmental, social and, governance (“ESG”) investment vehicles in retirement plans. According to the DOL, the proposal was designed to ensure that plan fiduciaries “may not invest in ESG vehicles when they understand an underlying investment strategy of the vehicle is to subordinate return or increase risk for the purpose of non-financial goals.” In other words, the DOL does not want the primary reason for ESG investment inclusion in retirement plans to be for social welfare. The proposed ruling caused some controversy and many believed the DOL proposed ruling was designed to make it more difficult to include ESG investments in retirement plans.

In November 2020, the DOL published its final ruling, Financial Factors in Selecting Plan Investments.

In part due to public comment and backlash regarding the proposed ruling (same title as final ruling), the DOL revised the publication and proceeded to take a softer position in regards to ESG investments. The final ruling no longer refers to “ESG” investments and instead focuses on “pecuniary” factors which are factors that have a material effect on risk and/or return of an investment.

Finally, on March 10, 2021, the DOL’s Employee Benefits Security Administration publicly stated that it will not enforce ruling on ESG investments until further guidance is published. Compared to its original ruling, the DOL has drastically reduced its oversight of plan fiduciaries and their inclusion of ESG investments in retirement plans and many anxiously await what is on the horizon for this increasingly popular asset class (see figure above).

COVID-19 A Year in Review

Just a year ago, the United States, and much of the rest of the world, experienced one of the fastest market declines in history. In only 22 trading days, the S&P 500 fell nearly 30%, officially recording the most rapid decline in the stock market ever, including the Great Depression of the 1930s. A year later, the U.S. Markets have not only recouped losses, but by many metrics have surpassed where we were in March 2020. From a retirement saver perspective, investors who stayed the course and were invested appropriately, likely reaped the benefits of a resilient market.

The disconnect between the stock market and economy was a major storyline throughout this past year. Often attributed to the forward-looking nature of the stock market, the disconnect between stock market performance and economic data illustrates a reality in which market performance does not necessarily correlate to the overall health of the economy.  While the stock market was quick to bounce back, the U.S. economy is slower to action, yet still moving toward a pre-COVID environment as well. The figure above shows the last 20 years of stock market and unemployment rate correlation. The last year is a perfect example of investor optimism as indicated by the market recovery beginning much sooner than the unemployment rate reduction. However, as we continue to see vaccinations roll out, this disconnect appears to be closer to connecting.

As of the end of March, unemployment hovered around 6%, down from the nearly 15% we saw in April 2020. While majority of Americans are getting back to work, there are several industries that are still negatively impacted by the pandemic—specifically the hospitality and services industry, which is still experiencing all-time high unemployment rates.  Alternatively, recent manufacturing data showed the manufacturing sector at its highest growth level since August 2018. In other economic news, GDP is expected to increase in Q1 (final data still to be released). Many predict GDP growth to be the strongest we’ve seen in decades due to the robust fiscal support and continued vaccination progress. As of Q1, roughly 30% of the United States’ total population has received at least one dose of the COVID-19 vaccine. According to an analysis performed by Vanguard, the U.S. should be able to reach herd immunity in the second half of the year.  The reopening of businesses coupled with pent-up consumer demand is expected to accelerate economic growth.

Though many businesses are beginning to reopen, the long term economic and societal impacts remain to be seen. Trends like increased remote working, urban population decay, and virtual events are unlikely to fade away. In many ways, the pandemic has altered our standard of living leaving many wondering what is the “new normal?”

If you enjoyed reading this, consider reaching out to a Forest Capital Management consultant to learn and discuss more.

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