The first quarter ended with last week continuing the trend of the previous four with stocks finishing higher. However, the sectors leading the market higher were not the ones we have become accustomed to seeing lead the charge. As rates on the 10-year U.S. Treasury rose 0.81% during the quarter, value stocks were provided a much-needed catalyst to overtake growth companies.
As the 10-year U.S. Treasury approaches the 2% level, after bottoming at just 0.52% last August, the stock market was forced to reevaluate the sectors that would provide the best opportunities for future returns. As yields rose in preparation for increasing growth and the reopening of the global economy, technology found itself the second-worst performing sector last quarter, beating only consumer staples. What led the market higher instead? The perennial out of favor energy sector posted a 31% return, with financials coming in second at 16%. Just one year ago, these were two of the most despised sectors as a barrel of oil traded in negative territory, interest rates lowered to rock bottom levels, and banks faced capital restrictions from the Federal Reserve. A year later, we are reminded of the importance of diversification and how quickly sector rotations can happen with no warning.
Sector rotations are not the only leadership change we have been experiencing; smaller capitalization stocks continued besting large cap companies, a trend that began in the fourth quarter. As measured by the Russell 2000 Index, small cap stocks outperformed their large cap counterparts by about 7% in the first quarter. This transition can also be viewed as a catalyst from the reopening trade. Smaller companies are thought of as being higher risk and more dependent on the economic environment. Hence, as investors become more willing to take additional risks, capital flows into small stocks.
Another sector forgotten about in 2020 was real estate. Some thought this was a dying industry— especially commercial real estate—as consumers transitioned to e-commerce for retail, restaurants were challenged, and houses turned into offices. The first quarter showed opinions from 2020 were an overreaction as the real estate index followed its value-oriented peers and rallied 10%.
While some market commentators were preaching “value investing is dead” last year, we have experienced a quick rotation to value stocks leading the market higher just a few short months later. This is another example to show no one knows what the next couple of months or even one year have in store for markets, but a diversified portfolio ensures exposure to what rotates into favor next.