GAME STOP, GAME STOP, GAME STOP…ok now that’s out of our system and we can all take a deep breath (while inhaling pollen) and enjoy the spring sunshine. The first quarter of this year brought more challenges but also a renewed sense of hope that things are beginning to look up in this crazy world we are living in. As for my family, we have enjoyed seeing the faces of our friends and neighbors as the temperatures are getting warmer. We hope you all enjoyed the holiday weekend!

As we begin the second quarter, it would be an understatement to say that investors have faced historic challenges over the past year. From the pandemic lockdowns to the sudden recovery, staying invested and maintaining a long-term view has been rewarded. During the first quarter, the S&P 500 gained 6.2% with dividends while the Dow rose 8.3%. This is true even though market and economic dynamics - and the resulting barrage of headlines - have made it difficult to feel comfortable with the bull market. Perhaps more than ever, investors need to stay disciplined on several challenging issues as this unique cycle evolves.

One year ago, the markets were hinged on the public health crisis as it spurred an economic crash, which in turn risked a credit crisis. Today, with the economy recovering and markets making new highs seemingly every week, the day-by-day state of the pandemic is less relevant to investors. Instead, attention has turned to the aftermath of the sharp crash and recovery: inflation, interest rates and taxes.

Inflation, which has been subdued for decades, is rising. However, there are two important distinctions to make. First, reflation, or prices returning to pre-pandemic levels, is different from runaway inflation. Even without excessive monetary and fiscal stimulus, it is natural to expect the prices of goods and services to normalize as the recovery continues.

Second, prices jumping for a small set of goods has different investment implications than a slow but broad rise in prices across the economy. For instance, the prices of gasoline, semiconductors, food and more have spiked due to supply and demand factors over the past several months. This may have sector and tactical implications for balanced portfolios. However, this is distinct from the slow erosion of purchasing power and savings that we historically associate with inflation. If this were to continue, it would generally favor asset classes such as stocks, real assets, TIPS (inflation protected bonds), etc.

Regardless of how we define inflation, it has already had a direct impact on markets. Interest rates have jumped this year across the board, from the 3-year to the 30-year government bond rate. The benchmark 10-year U.S. Treasury yield began the year at 0.91% and is now above 1.7%. These moves both reflect and influence the rotation that is occurring in the market. This has shifted returns from last year's high-fliers, especially in tech and growth, to small companies, value, and sectors poised to benefit during the recovery. Of course, it's important to be diversified across all of these areas of the stock market.

Despite rising rates, short-term rates are still pinned to their lows and even rising long-term rates are low by historical standards. The Fed has made it clear that it intends to keep monetary policy loose until at least 2023 in order to restore the job market to pre-pandemic levels. This means that those investors who rely on portfolio income will find little comfort, as has been the case since at least 2008. It will continue to be important to find alternative sources of yield while balancing the risks associated with interest rate volatility.

Additionally, taxes are increasingly top-of-mind for investors. Like inflation, taxes are a complex subject that affect everyone in many ways. At the moment, the pending infrastructure bill and other proposals may increase corporate taxes from 21% to 28%, and could raise the individual tax bills for high earners as well. Clearly, this would have an impact on individual and business income statements. From a portfolio construction standpoint, taxes can directly affect decisions on when and where to use tax advantaged accounts.

However, it's important to distinguish these specific effects from their impact on broad markets. The economy and the stock market have performed well in both low and high tax regimes over the past century, including when the top individual rates were around 90% and when corporate tax rates were 35%. For corporations especially, this is partly because the headline tax rate only tells part of the story and partly because companies tend to find a way to grow profitability regardless. So, while taxes are a hot political topic, and most would prefer lower tax bills all things considered, the effects on the market are not as clear-cut as it may seem.

These are all challenges that will play out over the coming quarters, and there will no doubt be new issues that investors need to grapple with as the cycle continues. As is always the case, maintaining investment discipline by understanding these concerns with a broad, historical context, is the best way for investors to achieve their financial goals. Below are two charts that help to put these investor concerns in the right perspective.

The stock market continues to reach new highs.

The market continues to grind higher despite a constant parade of investor concerns. In this environment, it's more important than ever to stay invested while avoiding complacency.

Interest rates have risen across the board.

Interest rates rose significantly during the first quarter and long-term rates could continue to increase as the recovery continues. The Fed has made it clear that they intend to keep short-term interest rates low, possibly until at least 2023. This could continue to steepen the yield curve in the coming quarters.

The bottom line? Investors have faced many challenges over the past year and during the first quarter. There will no doubt be more market volatility in the quarters ahead. Investors ought to remain disciplined and consider the challenges of inflation, interest rates, and taxes with a long-term perspective. As always, I am thankful that you continue to place your trust in me.