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BMT Monday Market Insights – January 19, 2020

Top Weekly Themes

  1. Chaos in Washington – On Wednesday, January 6, violent protests erupted as supporters of President Trump attempted to disrupt the Electoral College vote count, resulting in the formal nomination of President-elect Joe Biden. Irrespective of one’s political views, it’s reasonable to assume that the unfortunate events of last week are indicative of the level of bipartisan division currently existing within our country. The market, as measured by S&P 500 Index, shrugged off the latest round of political turmoil and rose 1.70% for the 5-day period following the events that unfolded at the U.S. Capitol. Hopefully, both sides of the political establishment will dial back bipartisan fervor, but odds of full-scale cooperation regarding future policy initiatives (taxes, climate change, international relations, etc.) appear relatively low. That said, we don’t see any reason to alter our financial market and economic outlook for 2021. The nation has endured numerous episodes of rising geopolitical tensions, ranging from military conflicts and scandals, such as Watergate and the Iran-Contra Affair, over the last 50 years. Other than occasional transitory spikes in volatility, such incidents have typically had minuscule effects on market returns over the long run.  
  2. Economic soft patch confirmed by recent employment data – On Friday, January 8, the U.S. Bureau of Labor Statistics released the December Non-Farm Payrolls report for the month of December. The data revealed that the U.S. economy lost 140,000 jobs in the final month of 2020. While the findings in this report are subject to future revisions, this marks the first month of net job losses since the early onset of COVID-19. As expected, the spike in virus cases had a more adverse impact on the services-oriented segments of the economy (i.e., leisure, hospitality). The most recent weekly initial jobless claims data (unemployment benefits) exceeded consensus expectations, thus further illustrating the weakness in the labor market. A languishing labor market will likely put further pressure on politicians to pass a stimulus bill to bridge the output gap as COVID-19 vaccinations ramp up.
  3. “Narrowness” applies not just to the overall market – In the past, we’ve commented on the degree of concentration of a select group of stocks and the material influence they can have on market returns. Even with the recent underperformance of FAANG (Facebook, Amazon, Apple, Netflix, Google), the five stocks still comprise more than 20% of the total weight of the S&P 500 Index.  Stock concentration is not unique to the market as a whole and applies to individual sectors as well.  Within Communication Services, Consumer Discretionary, Energy, and Information Technology, the three largest positions (based on market cap) account for more than 45% of the total weight of those respective sectors. We have always strived to maintain proper diversification across sectors, regions, and individual securities to mitigate concentration risk. While passive investing has its merits, investors may be unaware of the level of individual security risk they are taking by strictly relying on passive vehicles. We believe that a hybrid approach, one that blends active and passive management, can help to mitigate unwarranted levels of individual stock risk. 

Returns Table

EquitiesWeek (%)YTD (%)1-Year (%)3-Year (%)5-Year (%)Div Yield (%)
S&P 500                    (0.2)                     1.1                   17.7                   44.3                   118.21.49
Russell 1000 Value                     0.9                     3.8                     6.2                   19.8                      75.82.16
Russell 1000 Growth                    (0.9)                    (0.6)                   33.5                   76.1                   175.40.73
Russell 2000                     2.8                     9.2                   30.3                   41.0                   125.21.11
MSCI EAFE                     0.8                     2.9                   11.0                   14.2                      63.62.36*
MSCI EM (Emerging Markets)                     3.7                     6.2                   22.8                   23.2                   116.91.97*
Fixed IncomeWeekYTD1-Year3-Year5-YearDiv Yield
Bloomberg Barclays US Aggregate                    (0.0)                    (0.9)                     6.0                   16.4                      22.31.21
Bloomberg Barclays US High Yield – Corporate                     0.1                     0.3                     6.8                   19.4                      54.14.18
Bloomberg Barclays Municipal Bond                    (0.0)                    (0.0)                     4.3                   15.1                      20.21.08
Bloomberg Barclays Global Aggregate x US (Country)                    (0.3)                    (0.6)                     9.9                   12.6                      26.50.71
CommoditiesWeekYTD1-Year3-Year5-YearCurrent Level
Crude Oil WTI (NYM $/bbl) Continuous                     5.4                   10.4                    (8.0)                 (16.7)                      71.7                         53.6
Natural Gas (NYM $/mmbtu) Continuous                    (2.3)                     4.1                   20.3                 (17.8)                      23.0                           2.6
Gold NYMEX Near Term ($/ozt)                    (3.2)                    (2.3)                   20.0                   38.8                      72.3                   1,850.3
Copper Cash Official LME ($/mt)                    (0.4)                     3.4                   28.1                   13.2                      83.3                   8,002.5
Currencies1 Week AgoYTD1-Year Ago3-Years Ago5-Years AgoCurrent Level
U.S. Dollar per Euro                   1.23                   1.22                   1.11                   1.21                      1.08                         1.21
Japanese Yen per U.S. Dollar              103.94              103.25              110.04              111.32                 118.09                    103.83
U.S. Dollar per British Pounds                   1.35                   1.37                   1.30                   1.37                      1.44                         1.37
As of January 14, 2021 (close) *Dividend Yield For MSCI EAFE and MSCI EM are from 12/31/2020.

Chart of the Week: Interest Rates on the Move

The increase in the 10-Year Rate Since Year-End Was Historically Sharp

Source: Cornerstone Macro


  • The charts above show the 10-Year Treasury interest rate (chart on the left) and the distribution of 8-day interest rate moves since the beginning of 2010 (chart on the right). One observation is that interest rates across the yield curve are still historically low. This would be more obvious if the time series in the chart was extended out to the previous 40 or 50 years.
  • Although rates are still relatively low, the magnitude of the rise in rates (22 basis points) over the previous eight-day period, ending January 13, is something we have not typically seen in the past 10 years. Is the recent move an overreaction to recent statements from Fed officials about the possibility of a more restrictive monetary policy in 2022 or 2023? Or was it mainly attributed to the perception of fiscal stimulus exceeding consensus forecasts after the Democrats took control of the Senate? No one knows the exact reason; however, it is quite plausible that at least a portion of this rate move was caused by the anticipation of tighter Fed policy associated with stronger economic growth and higher inflation. The year is still young, and macroeconomic conditions can change, but for now, at least, the market seems to agree with our steeping yield curve thesis for 2021.
  • According to analysis conducted by BCA Research, equities posted slightly higher returns when interest rates declined over the past 35 years.  That said, we don’t think that rising rates pose a major risk to stocks at this point. Stocks suffered their worst returns when the Fed Funds rate (short-term interest rate) shot past the Federal Reserve’s nominal neutral rate estimate. The latter of which is derived by Fed officials and is the conceptual rate that neither stimulates nor curtails economic growth. Based on the current Fed Funds rate, it will likely take several years before we reach this tipping point. This does not mean that the stock market is impervious to future declines; however, the cause will likely not be attributed to an overly restrictive central bank policy. 

Commentary: A Closer Look at Potential Sources of Equity Returns

When the S&P 500 Index fell precipitously and entered the bear market territory in March 2020, virtually no investor predicted the Index would closeout 2020 with a positive return of 18.40% – we sure didn’t. What is even more astonishing is that the P/E multiple (the price investors are willing to pay for a dollar of earnings) has accounted for all the performance delivered by equities since the end of 2018[1] (see chart below).  Stock market returns can be decoupled using this simple equation: earnings growth + dividend yield +/- P/E multiple expansion/contraction. To predict equity returns, one would have to render a forecast that considers each of these variables.

S&P 500 Return Breakdown (2019-2020)

Source: Cornerstone Macro

We are reasonably comfortable saying that we don’t think the dividend yield for the market is going to materially change. So that leaves the two other sources of returns. We don’t think the equity market multiple is in jeopardy of falling off a cliff, but believe it’s reasonable to assume that the equity multiples can’t expand much further from current levels. Valuations are extremely difficult to gauge, but it is hard to ignore the fact that the current NTM P/E ratio of 22.5x (end of 2020) ranks in the 94th percentile of all monthly observations dating back to 1985. 

For stocks to move further from here, earnings growth will have to carry the baton. The good news is that sell-side analysts are estimating earnings will grow north of 16% in 2021. The bad news is that analyst estimates are typically too optimistic and actual earnings growth is typically 4%-5% less than what is forecasted. All said, it’s imperative that the equities we manage deliver on the earnings front, because we cannot expect equity multiples to move in our favor.


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