Market Commentary March 2021
Fed predicts strong growth in 2021
The Federal Reserve reiterated a conditional pledge not to raise interest rates for years to come and forecast the U.S. economy would expand by 6.5% in 2021, the fastest since 1984, after Washington approved the $1.9 trillion American Rescue Plan. Under the plan, Americans received $1400 cheques, which helped to buoy optimism for the retail sector, despite a 3% drop-off in retail sales in February.
Inflation fears push US Treasury yields higher
A combination of fears about rising inflation, and the Fed’s assurance that rates would not be raised, caused a sell-off in US Treasuries, which drove the 10-year Treasury yield up to 1.75%. This caused jitters among equity investors, reminiscent of Q1 2018, when a rise in the 10-year Treasury yield above 3% triggered a 10% correction in US and global equities. This exacerbated the volatility in the equity market, as investors rotated out of the high growth areas, such as technology, and into more cyclical sectors, such as financials.
Vaccine roll-out still stumbling in Europe
Many areas of the EU reported a third wave of Covid-19, as countries substantially failed to roll-out vaccines to the population. EU nations reported difficulties in obtaining sufficient vaccine, as well as a shortage of the necessary equipment, such as needles and various other logistical problems. The prospect of growing case numbers and further lockdowns did not, however, hamper the performance of the equity market, which focused on positive economic data (Manufacturing PMI numbers), and turned in strong positive returns for the month.
Emerging markets hit by Fed comments and stronger dollar
Emerging markets suffered during March, as the pronouncements from the Federal Reserve seemed to set the scene for a period of dollar strength. The dollar Index reached its November 2020 high, gaining against other major currencies. Emerging markets, which have large amounts of US dollar debt, performed strongly last year, when the US currency was weakening, but showed a marked loss in March as the dollar rebounded strongly. No one region was especially weak, and there were positive performances from a number of individual markets, but the overall return was negative.
During March, global equity markets generally saw a rally into the end of Q1, with strong performances coming from all the major markets. The exception to this was the emerging markets, which were mostly lower, reflecting the stronger dollar and improving outlook for the US economy. Within the headline figures, markets continued to see a rally in value stocks, and profit taking from some of the growth sectors that had done well in 2020, most notably technology. Major economies benefited from the roll-out of the Covid-19 vaccines, and the price of Brent Crude oil stabilising above $60, up from its low of $20 last March.
European markets defied gravity in March, as investors pushed most markets higher. Despite concerns over the very poor pace of vaccine roll-out, and the historically low support for Angela Merkel’s CDU party in the recent state elections, investors focused on strong manufacturing PMI data (hitting a record high on a rebound in demand). Whilst the EU services sector continued to contract, in Germany the sector returned to expansion in March. Improving sentiment towards the US economic recovery also drove an increase in demand for riskier assets, supporting Europe’s smaller markets. UK returns continued to be driven by the mid-cap stocks, which are less affected by currency volatility.
Once again in March, Sterling continued to perform strongly against many other major currencies. The dollar, however, enjoyed a very strong month, particularly against the yen, as investors, fearful of rising inflation this year, drove the 10y Treasury yield up as high as 1.75% at the month end. The dollar Index regained its November 2020 high, as the Fed predicted lower unemployment, higher inflation and the fastest economic growth in decades (6.5% in 2021). Despite a 3% decline in retail spending in February, the $1400 support cheques landing on doormats across America (as part of the $1.9tr America Rescue Plan) led to a rosy outlook for the sector.
Despite a strong rise in the 10-year US Treasury yield, other global sovereign markets did not follow suit. In particular, Japan and the weaker EU nations saw their 10-year yields contract visibly, as investors continued to search for the optimum risk/reward balance in fixed income. Major EU nations, and the Eurozone as a whole, saw little change, with yields already being negative. For the UK investor, currency movements served to reduce volatility in fixed income markets. Gains in EU bonds were reduced by the strength of the pound vs the euro, whilst losses in US bonds were mitigated by the stronger dollar.
*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.
March provided a case study in the foolishness of betting against the Fed – something that conventional market wisdom warns investors never to do.
Having seen the dollar weaken more-or-less steadily during the last year of the outgoing President Trump, it was only to be expected that President Biden might enjoy something of a honeymoon period, whilst the markets sized up the man and his policies. However, what we perhaps did not expect was to see such an early and dramatic move from both the Fed and the president, to support the economy. The $1.9 tr American Rescue Plan will see $1400 relief payments made to almost all Americans with a gross income of less than $75,000. The magnitude of this stimulus package seems to be more than enough to allow investors to look past any short-term hiatus in retail sales. In addition, the Fed has restated its position on interest rates, and predicted that 2021 will see the highest GDP growth in decades, some 6.5%. This follows a contraction of 3.5% in 2020; it is therefore not surprising that US equity markets have been ebullient in recent weeks.
What has been driving the most recent rally is the long-awaited broadening of the recovery. For most of the period since last March, the market was driven by a small number of sectors, most notably technology, which had shown themselves to be resilient during the first wave of the Covid crisis (either by good fortune, or by the nature of their business model). Many equity funds failed to keep pace, simply because they were diversified and included sectors that had not yet begun to recover. What we have seen over the past few months, however, is a rotation by investors out of those sectors, and into more traditional and cyclical industries, such as industrials, resources and retail banking. This is a healthy turn of events, given the high valuations that had been placed on some stocks, such as Tesla, or Plug Power, and the feeding frenzy surrounding others, such as Gamestop.
This rotation can be most readily seen in the US, where detailed data is available. The charts below look at the relative strength of different market sectors (the sector index divided by the S&P 500 Index). A number of sectors have seen their relative strength fall away over the past six months, such as:
Whilst other sectors have been the beneficiaries of this rotation, seeing their relative strength rise significantly:
But, as is usually the case, the equity market shows only one half of the picture. In order to understand the continuing strength of the broad equity market, it is necessary to look at the bond market. Investors, during the decade following the Global Financial Crisis of 2008, had become complacent, and had become accustomed to an environment of ongoing quantitative easing and low rates. As the world economy began to pick up, there were suggestions that the time had come to begin factoring in rate rises in the major economies. Talk of tapering the QE programme had been met with very adverse reactions in the bond market, such as in 2013 ‘Taper tantrum’, and, at the start of 2018, economic forecasts mostly indicated an expectation of 3-4 rate rises in the US that year. What happened next was a rapid rise in government bond yields to more than 3.3%, as bond investors, expecting rate rises, were not prepared to pay the same high price for low-yielding bonds, causing prices to fall and yields to rise. This also drove a 10% sell-off in equities, as equity investors, seeing a steepening yield curve, became increasingly concerned that rate rises would be imminent, and, with inflation below the Fed’s target, would be damaging for equities.
Whilst the most recent rise in bond yields in 2021 has spooked the market to some degree, the renewed comments from the Fed on its policy of no rate rises for years to come has most likely been a major factor in calming nerves and avoiding a further market correction. March’s Fed minutes also showed an awareness of the importance of forward guidance for markets. So don’t fight the Fed – the US government has more money than you do.
Disclaimer: The information contained in this report is for illustrative purposes only and should not be construed as a solicitation nor offer, nor recommendation to acquire or dispose of any investment. Specifically, the share class used to create the illustrations may not be available on all platforms nor be suitable for individual investors. This report was produced by Collidr Research (“Collidr”) for Affinity Integrated Wealth Management (AIWM) and while AIWM and Collidr use reasonable efforts to obtain information from sources which they believe to be reliable, neither AIWM nor Collidr make any representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are subject to change without notice. Model returns are calculated using the most appropriate share class of the underlying funds, having regard to the illustrative nature of the report, with all income being reinvested. As a result, real portfolio performance may vary from model performance. Where model portfolio histories are shorter than three years, historic model returns are substituted prior to inception date with returns from an Collidr performance benchmark. This benchmark is constructed from the average returns of all Collidr portfolios with similar risk profiles that existed during that time. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. Affinity Integrated Wealth Management is a trading style of Buryfield Grange Limited, Buryfield Grange Life Planning Limited and Affinity Integrated Wealth Management Ltd. ‘Buryfield Grange Limited’ is authorised and regulated by The Financial Conduct Authority. Not all services provided by Buryfield Grange are regulated by the Financial Conduct Authority. ‘Buryfield Grange Limited’ is registered in England and Wales at Inspire House, 20 Tonbridge Road, Maidstone, Kent, ME16 8RT. Company registration number 4568338. Collidr Research is a trading name of Collidr Technologies Limited, registered in England and Wales at 34 Southwark Bridge Road, London, SE1 9EU. Company registration number 09061794. Data Providers: Bloomberg L.P. and Collidr.
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