Top Weekly Themes
- Small-Cap Stocks Take a Breather – Since peaking on February 9, the Russell 2000 Index (a proxy for U.S. small-cap stocks) has fallen about 3.5%. However, the Index is still up 12.4% for the year-to-date period as of February 18. Since early September 2020, small caps have outperformed their large-cap brethren by nearly 30%. Based on research conducted by Cornerstone Macro, the Russell 2000 Index is the farthest above its 150-day moving average price level since the Index’s inception (1978). One may question whether our overweight position to small caps is justified given the magnitude of the rally. Furthermore, subsequent one-year returns for the Russell 2000 Index, both absolute and relative to the S&P 500, have been subpar when comparable levels of price momentum were previously witnessed. While small-cap equity prices are a bit stretched and are arguably overdue for a pullback, we still think this cyclical recovery has room to run given the degree of monetary and fiscal stimulus injected into the economy. Small-cap stocks, especially those concentrated in more value-oriented sectors, will likely continue to benefit as the economic momentum builds. Even with the recent rally, the Russell 2000 Value Index has lagged the Russell 1000 Growth Index by over 6% per annum over the past 13 years. Small-cap value stocks have a long way to go in terms of closing this performance gap.
- FOMC Minutes Reveal No Surprises – The Federal Open Market Committee (FOMC) minutes were released on February 17. No commentary contradicted the dovish statements made during the Fed’s late January meeting. There were positive revisions to economic growth in lieu of pending fiscal stimulus, but the minutes revealed that “economic conditions were currently far from the Committee’s longer-run goals.” FOMC participants expressed concerns about the pandemic having a more negative impact on disadvantaged segments of the U.S. population and expressed very little concern on the inflation front. The rise in 10-year breakeven inflation rates and an upward shift in the trajectory of the Fed Funds rate implied by futures markets, seem to be at odds with the central bank’s views. Rates held steady after the FOMC commentary was released last Wednesday. However, 10-year Treasury yields have risen about 0.30% for the 3 weeks between the Fed’s January meeting and the public dissemination of the minutes. We still believe it is likely that long-term rates will drift modestly higher throughout the course of 2021 as the economy strengthens.
- Economic Soft Patch Likely in the Rearview Mirror – Although Initial Claims (worker unemployment benefits) figures released last week remain stubbornly high, other economic reports provide evidence that the economic growth is accelerating. Industrial Production exceeded consensus estimates and is back to pre-pandemic levels. Retail Sales hit an all-time high in January with strong readings from a wide array of services-oriented sectors. Consumers now have roughly $1.5 trillion more in savings versus this time last year. This number does not include stimulus checks that will likely hit consumer wallets over the next couple of months. We would not be surprised to see upward revisions to economic growth forecasts as personal consumption expenditures continue to trend higher.
|Equities||Week (%)||YTD (%)||1-Year (%)||3-Year (%)||5-Year (%)||Div Yield (%)|
|Russell 1000 Value||0.3||5.5||7.5||7.85||12.28||2.08|
|Russell 1000 Growth||(0.6)||4.4||33.3||23.06||23.80||0.70|
|MSCI EM (Emerging Markets)||(0.2)||10.5||33.4||8.85||16.93||1.85*|
|Fixed Income||Week||YTD||1-Year||3-Year||5-Year||Div Yield|
|Bloomberg Barclays US Aggregate||(0.6)||(1.5)||3.8||5.57||3.73||1.30|
|Bloomberg Barclays US High Yield – Corporate||(0.1)||1.3||7.3||6.86||9.51||3.99|
|Bloomberg Barclays Municipal Bond||(0.5)||0.5||3.7||5.34||3.68||1.00|
|Bloomberg Barclays Global Aggregate x US (Country)||(1.1)||(2.2)||7.9||2.70||3.70||0.83|
|Crude Oil WTI (NYM $/bbl) Continuous||3.9||24.8||16.3||(0.6)||14.5||60.5|
|Natural Gas (NYM $/mmbtu) Continuous||7.5||22.0||55.6||6.4||10.7||3.1|
|Gold NYMEX Near Term ($/ozt)||(2.8)||(6.3)||10.8||9.4||7.7||1,773.4|
|Copper Cash Official LME ($/mt)||4.3||11.7||51.0||6.5||13.6||8,650.0|
|Currencies||1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.21||1.22||1.08||1.24||1.11||1.21|
|Japanese Yen per U.S. Dollar||104.73||103.25||109.81||106.05||113.62||105.79|
|U.S. Dollar per British Pounds||1.38||1.37||1.30||1.40||1.44||1.39|
Charts of the Week: Favorable Developments on the COVID-19 Front
- The first chart above shows daily COVID-19 cases since the onset of the pandemic. While the number of cases is still elevated compared to late fall 2020, there has been a steep decline in both the number of new cases and hospitalizations over the past 30 days. This decline from mid-January occurred when vaccination rates were less than 5%. The second chart shows the total number of reported COVID-19 cases and an estimate of the total number of people infected since the onset of the pandemic.
- If vaccination levels continue to rise and recently reported virus variants don’t result in a spike in new cases, it’s quite possible that more than three-quarters of the U.S. adult population could be immune to the virus by late spring.
- As cases fall, politicians will be under political pressure to re-open the economy. This has already occurred in many states. A rollback of government-mandated lockdowns could very well happen as consumers receive another stimulus check. All these factors combined make it likely that economic growth and corporate profits will continue to accelerate, especially over the back-half of this year.
Commentary: Have Investors Become Overly Complacent?
Since the depths of the virus-induced bear market, stocks have experienced a significant rally with the S&P 500 Index up over 75%. The tech-laden NASDAQ and Russell 2000 Index had a more impressive run, more than doubling over this period. Within the Russell 3000 Index, more than two-hundred stocks are up over 300%. It’s reasonable to presume investor fervor is rampant in the market. Speculative trading activity in high beta stocks, combined with the massive price spike in several cryptocurrencies, further substantiates this contention.
Even in a low interest-rate environment, there have been six times during the past ten years when the S&P Index declined at least 10%. Equity valuations were also lower at the start of these periods compared to today. So, we don’t think that equities are impervious to a pullback over the next several months.
S&P 500 Return Market Corrections
While we are somewhat concerned about the speculative market behavior, we don’t believe that a prolonged downturn is likely. One reason is that money supply growth will continue at levels not seen since the end of World War II. There is ample liquidity available to stimulate the economy; a portion of it will likely be used to finance asset purchases. Equity valuations are expensive with the S&P 500 trading at P/E ratio of 23x, based on Next Twelve Month (NTM) earnings. However, bonds are arguably more overpriced despite the recent rise in rates. The dividend yield of large-cap stocks is still greater than the interest rate of 10-year Treasury bonds. These two asset classes are constantly competing for investor dollars. Unless there is an inflation scare that triggers a significant spike in interest rates, which is unlikely in our opinion, we think equities are more attractive than bonds.