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BMT Monday Market Insights – February 16, 2021

Top Weekly Themes

  1. Too far, too fast? – Equity markets began last week with major U.S. indices reaching fresh record highs.   Vaccine distribution, declining U.S. COVID-19 cases, low interest rates, and the potential for additional fiscal stimulus have contributed to positive investor sentiment. Last week marked the 64th consecutive day that over 75% of S&P 500 stocks traded above their respective 200-day moving averages. Although this might feel like the market needs a breather, the current streak is still well shy of 2004 (219 days), 1983 (210 days), and 2013 (193 days). Each of these periods proved to be the early/middle stages of a multi-year advance…not the end.  At BMT, we expect accelerating global economic growth and improving earnings expectations to drive equities higher. We continue to favor small/mid-cap and cyclical/value-oriented companies within this environment.
  2. Labor market remains weak – Increasing COVID-19 cases over the holidays weighed on company hiring for the second consecutive month in January. The unemployment rate dipped to 6.3%, but partly because individuals exited the labor force. There remain about 10 million more people without jobs compared to a year ago. Markets are anticipating additional fiscal aid to provide needed labor market support while vaccine distribution ramps up. Although initial estimates for the next round of stimulus fell well short of the proposed $1.9 trillion, many now believe the price tag will come much closer to the $1.9 trillion number. According to Strategas, Democrats passing a budget with the authority to spend $1.9 trillion, combined with less opposition from moderate Democrats, increases the chances of a sizeable package somewhere between $1.5 trillion and $1.9 trillion.  
  3. Junk bond yields drop to record lows – Investors have turned to the high-yield markets in search of yield, as safer fixed income sectors offer little in the way of return. The increased demand has driven high-yield credit spreads even tighter, with the yield on the Bloomberg Barclays US Corporate High Yield Bond Index hitting 3.95% last week, a historical low for the Index. We believe the combination of improving economic fundamentals and ever-growing central bank balance sheets will continue to support high-yield bonds. However, we recognize, given the low yield environment, that managing duration risk for the asset class becomes even more important. Recently, within certain BMT taxable bond strategies, we added exposure to higher yielding issuers within the bank loan sector. Given tight credit spreads and low yields, bank loans, and their very low duration are well positioned to perform within an expanding U.S. economy.

Returns Table

EquitiesWeek (%)YTD (%)1-Year (%)3-Year (%)5-Year (%)Div Yield (%)
S&P 500 1.24.418.816.5618.771.44
Russell 1000 Value 1.9 5.2 7.09.1713.382.10
Russell 1000 Growth 1.2 5.135.725.2525.130.70
Russell 2000 3.815.838.117.2320.751.02
MSCI EAFE 2.6 3.512.27.0011.732.35*
MSCI EM (Emerging Markets) 2.910.733.210.7218.051.85*
Fixed IncomeWeekYTD1-Year3-Year5-YearDiv Yield
Bloomberg Barclays US Aggregate 0.0(0.9) 4.65.693.771.20
Bloomberg Barclays US High Yield – Corporate 0.4 1.3 7.57.1710.043.95
Bloomberg Barclays Municipal Bond 0.3 1.0 4.55.493.720.90
Bloomberg Barclays Global Aggregate x US (Country) 0.9(1.1) 8.93.663.640.76
CommoditiesWeekYTD1-Year3-Year5-YearCurrent Level
Crude Oil WTI (NYM $/bbl) Continuous 3.620.016.6(0.5)17.358.2
Natural Gas (NYM $/mmbtu) Continuous(2.3)13.560.4 3.57.52.9
Gold NYMEX Near Term ($/ozt) 2.0(3.6)16.611.67.91,824.9
Copper Cash Official LME ($/mt) 5.9 7.145.6 7.113.18,292.0
Currencies1 Week AgoYTD1-Year Ago3-Years Ago5-Years AgoCurrent Level
U.S. Dollar per Euro1.201.221.091.22 1.13 1.21
Japanese Yen per U.S. Dollar105.42103.25109.92108.69 111.88104.73
U.S. Dollar per British Pounds1.371.371.291.38 1.44 1.38
As of February 11, 2021 (close). Three-year and 5-year returns are annualized. *Dividend Yield For MSCI EAFE and MSCI EM are from 1/29/2021.

Chart of the Week

U.S. Treasury Cash Balance Federal Reserve Account
(December 31, 2016 – February 3, 2021)

Source: Bloomberg, Inc.

Takeaways

  • Intermediate and long-term U.S. Treasury yields have been drifting higher this year, driven by higher inflation expectations, vaccine distribution, and a brighter economic outlook. The 10-year U.S. Treasury yield has risen 25 basis points (0.25%) this year, while the 30-year Treasury bond reached 2.0% during intraday trading last week for the first time in over a year.
  • Firmly anchored by the Federal Reserve, shorter-term yields have mostly remained stagnant, with some tenures trending lower. In fact, the two-year U.S. Treasury yield hit a new record low this month at roughly 10 basis points (0.101%). Short-term yields have been more influenced by dovish Fed monetary policy and the substantial amounts of cash and liquidity that have been searching for a home within short-term investments.
  • Potentially adding more pressure to short-term interest rates, the U.S. government is well-positioned to inject additional cash in the upcoming months given its roughly $1.6 trillion cash balance at the Fed and the likelihood that more fiscal aid will be distributed.
  • A decreasing cash balance will contribute to more funds circulating within households and business balance sheets in need of a parking spot. Demand for short-term investment vehicles is likely to remain very strong, putting continued downward pressure on short-term yields that are already depressed given current monetary policy.
  • We believe the U.S. Treasury yield curve will therefore continue to steepen this year. Longer-term yields will be pressured higher as more fiscal stimulus supports U.S. economic growth.

Commentary

U.S. Breakeven 10 Year
(December 31, 2012 – February 9, 2021)

Source: Bloomberg, Inc.

Inflation on the rise? – inflation expectations have been steadily increasing since mid-March of last year. The 10-year breakeven even rate hit 2.20% last week, the highest level since 2014, implying that investors believe annual inflation will average 2.20% over the next 10 years. Higher inflation would certainly be welcomed news for Fed officials who continue to caution investors that structural disinflationary factors such as globalization, technology, and an aging population still exist.

It’s important to keep in mind that the Fed is focused on sustainable inflation. Some degree of inflation in the short-term is certainly possible in the U.S. given pent up consumer demand, high personal savings rate, the likelihood of additional fiscal stimulus, and demand/supply imbalances for certain products/services that will most likely occur when the U.S. economy fully opens. However, the Fed will be monitoring how persistent inflation is over the medium term and will most likely look beyond short-term inflation rate changes when adjusting monetary policy.

We believe that inflation will rise gradually over the medium term, and coincide with positive economic growth. The labor market will continue to improve, but there remains a sizeable gap between today’s 6.3% unemployment rate and the 3.5% reached during the last expansion that didn’t trigger unwanted inflation. Combined with the structural issues that have weighed on inflationary pressures in the U.S. and other developed economies over recent years, we expect the Fed to stay on course with low interest rates through their projected 2023 timeframe and not pre-emptively react to short-term inflationary pressures.

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