Top Weekly Themes:
- Long-term Interest Rates Tail Off – Since bottoming in early August 2020, 10-year bond yields have trended higher and have risen more sharply thus far in 2021. Several different factors, most notably an improving macroeconomic outlook given the rollout of COVID-19 vaccines, have caused interest rates to climb by more than 120 basis points (1.20%). While we thought rates would drift higher and the yield curve would steepen, the magnitude of the movement exceeded our expectations. Over the past few trading sessions, bond prices have rallied and rates have fallen by about 15 basis points (0.15%). Is this an ominous sign for the economy and stock market going forward? We don’t believe so, and view the recent interest rate retracement as more of an over-extended trend that was due for a counter move in the opposite direction. The fall in rates could also be attributed to increased Treasury bond demand from overseas buyers, given the yield premium offered by Treasuries, even when accounting for currency hedging costs. The recent strength in the dollar appears to corroborate this narrative. As more vaccines are distributed and global economic growth accelerates, we think the previous trend of rising rates and a weakening dollar will likely resume.
- More Fiscal Stimulus – The Biden Administration plans to release further details of an additional fiscal stimulus package that is unrelated to the pandemic. Based on preliminary reports distributed to the media, roughly $3-4 trillion of additional government spending will be injected into the economy over the next 5-10 years. The package will likely be split into two separate bills. The first will focus on infrastructure-related investments (bridges, roads, railways, broadband access) and clean energy. The second proposal pertains to “human infrastructure,” or government spending on programs to make education more accessible (free community college, universal pre-K enrollment), increase the labor participation rate (national paid leave, support for child care), and offer assistance to help individuals buy health insurance. Unlike the COVID-19 related relief packages, a portion of this spending bill will be financed by higher taxes on individuals in upper-income brackets and corporations. There is also a provision that will enable the government to reduce expenses by negotiating Medicare prescription drug prices. The investment implications are quite difficult to ascertain. On the surface, it appears this spending bill is a net positive for the Industrials sector. However, we would not advise making wholesale asset allocation changes based on government fiscal policy. Pundits thought the Trump Administration proposals would be a net positive for Financials and Energy, which were the two worst performing sectors within the S&P 500 Index the previous four years.
- Elevated PMIs Bolster Cyclical Stocks – Both Services and Manufacturing PMI data released by U.S. Markit Services remained at elevated levels, thus foreshadowing a strong economic recovery. Elevated PMIs, which are leading economic indicators, have historically led to positive earnings revisions for stocks. More recently, cyclical sectors (Energy, Financials, Materials) have had the most significant positive earnings revisions and momentum. Small-cap equities have also seen more robust earnings growth compared to their large-cap counterparts. Value and small-cap stocks have risen sharply in advance of the robust earnings recovery, but we still believe that the market environment will be favorable for these areas in 2021, given the continued strength of leading economic indicators.
|Equities||Week (%)||YTD (%)||1-Year (%)||3-Year (%)||5-Year (%)||Div Yield (%)|
|Russell 1000 Value||(0.6)||10.2||61.0||11.50||11.74||2.02|
|Russell 1000 Growth||(0.0)||(1.4)||66.0||22.49||20.88||0.75|
|MSCI EM (Emerging Markets)||(4.3)||0.1||57.9||6.09||12.62||1.82*|
|Fixed Income||Week||YTD||1-Year||3-Year||5-Year||Div Yield|
|Bloomberg Barclays US Aggregate||0.5||(3.1)||2.4||4.92||3.28||1.56|
|Bloomberg Barclays US High Yield – Corporate||0.5||0.5||30.7||6.76||8.06||4.38|
|Bloomberg Barclays Municipal Bond||0.4||(0.4)||8.8||5.00||3.58||1.17|
|Bloomberg Barclays Global Aggregate x US (Country)||(0.3)||(4.4)||10.6||1.72||2.81||0.88|
|Crude Oil WTI (NYM $/bbl) Continuous||(2.5)||20.7||139.1||(3.9)||8.2||58.6|
|Natural Gas (NYM $/mmbtu) Continuous||4.2||3.6||52.6||(0.2)||7.7||2.6|
|Gold NYMEX Near Term ($/ozt)||(0.4)||(8.9)||5.7||8.5||7.1||1,724.9|
|Copper Cash Official LME ($/mt)||(3.4)||13.4||84.7||9.7||12.2||8,781.0|
|Currencies||1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.19||1.22||1.08||1.24||1.12||1.18|
|Japanese Yen per U.S. Dollar||108.98||103.25||111.44||104.88||112.65||109.14|
|U.S. Dollar per British Pounds||1.39||1.37||1.18||1.42||1.41||1.37|
Chart of the Week: What’s Next for the Stock Market After a Substantial Recovery?
Best 12-Month Rally in 75 Years
- The chart above puts the recent stock market rally in a historical context. Over the past 12 months, the S&P 500 Index has risen nearly 75%. This is the most significant price appreciation witnessed over a 12-month stretch during the past 75 years. Even the beginning of the secular bull markets that commenced in July 1982 and March 2009 did not provide the same level of gains over a 12-month stretch in comparison to what has been registered following the March 2020 low.
- As indicated by the data above, returns have been lackluster and below historical averages over the subsequent three- and six-month periods following the ten best stock market rallies over the past 75 years. However, returns over the ensuing 12-month period were positive in all but one period and were modestly above historical averages. No two market environments are the same, and the sample size of the data listed above is somewhat limited. Therefore, there are no definite conclusions to be drawn. That said, we would not be surprised if the market follows a similar pattern going forward – several months of consolidation with little ground being gained and then a rally over the back half of the year as the economy continues to gain steam.
- As we’ve stated in the past, future gains in 2021 will likely come from earnings growth, unlike a material rise in market multiples (P/E ratios) experienced over the past twelve months.
Commentary: Why Not Forgo Diversification and Seek the Next Version of FAANG Instead?
When investors look at a 20-year price chart of stocks like Amazon and Apple, they may question the validity of portfolio diversification. A portfolio that has risen three- or four-fold over this period pales in comparison to the two aforementioned stocks that have risen more the 25,000%. There is a natural human tendency to get lured by stories of certain investors and/or entrepreneurs, that by some combination of luck or skill, accumulated vast amounts of wealth by making a handful of highly concentrated investments. Over the next twenty years, the market will likely produce a new mix of innovative/disruptive businesses and a certain number of stocks that appreciate 40 or 50 times their original value.
So, is the concept of diversification overrated? We don’t think so, and for good reason. It’s hard not to dwell on opportunities missed by not having a sizable investment in some of the top-performing stocks; however, the probability of finding such investments is extremely low, as indicated by the charts below.
Distribution of Excess Returns on Individual stocks vs. Russell 3000, 1980-2020
Stock Returns Sorted by Sector vs. Russell 3000, 1980-2020
Based on an analysis conducted by JP Morgan Asset Management, the average stock lags the broad market, as measured by the Russell 3000 Index, roughly two-thirds of the time. In addition, a large percentage of stocks have even lagged cash over the past 40 years. As you can see in the first chart listed above, there is a significant “left-tailed” distribution curve – meaning a much greater likelihood of owning a bottom performer than a top performer. We believe that successful investing over the long-term, whether it’s investing in individual stocks, picking third-party investment solutions, or making asset allocation decisions, should aim to mitigate the potential damage associated with highly concentrated bets.