March 2021 - Market Commentary
Equity returns since the March-2020 lows have been substantial in many individual securities and sectors, volatility has been relatively muted, and market participants have been exuberant going long and short speculative stocks.
Vaccine developments continued to bolster positive sentiment within the “re-opening” theme with Johnson & Johnson recently announcing a single-shot vaccine that was 85% effective in preventing severe diseases in a Phase 3 study.[i] The U.S. has delivered ~100M doses of vaccines across the country with 78M already administered. 26.8M people have received both doses implying ~8% of the total U.S. population has been fully vaccinated. Moderna, Inc. released a statement indicating it can provide more than 40M doses of its vaccine per month by April. [ii]
According to the Bureau of Labor Statistics (BLS), the civilian unemployment level for the month of February of 6.3% is down from 14.8% during the initial COVID-19 lock-downs in April 2020, but up from a 20-year unemployment low in February 2020 of 3.5%.[iii] Meanwhile, the Institute for Supply-Chain Management (ISM) index on business activity continues to point to accelerating growth on the manufacturing side with readings reflecting a solid economic upcycle. The services economy, which was hardest hit by COVID-19, is also showing strength across numerous sectors as well.[iv]
In late-February however (almost overnight it seemed), the strong demand data exacerbated existing inflation fears and market participants sold long-term government bonds (as fixed interest payments decline in real value terms), and yield on the 10-Year Bond rose 32% from 1.09% to 1.44% in the month.[v] Stock/bond prices are a function of an uncertain/certain stream of cash flows in the future, discounted back to today. When inflation increases, a higher discount factor is applied to said cash flows, resulting in the lower prices we briefly saw in late-February. Additionally, the end of the month saw a spike in the volatility index to a slightly concerning level, but the increase was very short-lived as total market trading volume was weak, and stocks/bonds stabilized by month’s end.
For the month and YTD, the technology sector, which has been the catalyst behind much of the equity market gains for the past few years, trailed the broader market slightly. Higher inflation drives higher discount rates applied to these growth expectations and as a result, prices were under pressure compared to what investors have become accustomed to within the large cap Technology space during the low interest rate regimes post-2018.
Sector and asset class returns during the month of January & February were very consistent with our broad economic views that the U.S. is in the midst of a reflationary cycle; meaning the year-on-year growth rates in GDP growth AND inflation are improving. Regarding growth, the previously mentioned ISM data should translate into robust reported earnings from U.S. corporations on a year-over-year growth basis in 1HCY21 due to a very low base level created by COVID-19.
Given the rise in commodity prices in February, the current market narrative centers around an inflationary breakout. Individuals see this phenomenon arising in food, shelter, and gasoline prices. U.S. corporations are reporting raw material shortages across numerous sectors as plant manager’s struggle to balance improving demand with limited capacity. As a result, commodity prices continue to accelerate to the upside as well. This could bode well for more “old economy” sectors such as Energy, Industrials, and Materials which are relatively more dependent on inflation dynamics. Higher inflation typically results in higher long-term interest rates as well which is a headwind for Treasury bonds.
We believe when more normalized year-on-year comparisons arise mid-2021 and into 2022, corporate earnings growth (relative to today) will appear less stellar. Over the next few months we expect market participants to begin discounting a potential demand down-cycle in 2022 and there might be some bumps along the road as the “true” picture of the U.S. economy is revealed in the Summer/Fall of 2021. The stock market is a discounting mechanism meaning current prices reflect investor’s expectations of the future. That said, with accommodative monetary policy and fiscal stimulus in the pipeline, stock prices may prove, yet again, resilient to all economic backdrops.
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