Market Strategy 3/22/2021

Key Takeaways

• The yield on the 10-year US Treasury advanced last week, rattling the equity market on inflation concerns tied to the latest tranche of stimulus and prospects for more this year.
• Oil prices dropped on near-term demand concerns and a strengthening of the US dollar.
• Value stocks continue to outperform growth stocks across all Russell market cap segments.
• The latest FactSet earnings estimates for 2021 at $174.84 represent a 28.6% increase against $135.17 in calendar year 2020. 

The yield on the 10-year US Treasury which began the year at 0.913% closed at 1.721% last Friday. That’s 88.4% higher from where it stood at the beginning of this year.

While such a percentage increase in yield is dramatic from a percentage point of view the likely reality is that the move in yields may suggest that “things” are indeed “getting better” and pointing toward re-openings in areas of the US economy that have been shuttered or near shuttered for much of the duration since the rise of the pandemic last year.

In our view it would be much more worrisome at this juncture to see yields falling in the face of: improved vaccine distribution, the relative wide acceptance of the vaccines by Americans, the high level of vaccine efficacy thus far, resilient economic data—especially with consideration of what the country has been through and the recent completion of Q4 earnings season which saw corporate earnings of the S&P 500 significantly exceed consensus forecasts made at the start of the earnings season.

For now we’d expect the transition from pandemic to post pandemic to remain rife with news that could on any given day obscure the signal of the progress being made toward an economic recovery and beyond that most probably a sustainable economic expansion.

The bond market’s turbulence and protest has served to take some of the froth out of segments of the equity markets where equity valuations had gotten stretched; shook awake some investors who might have been prone to grow complacent as the markets ticked higher by the day; as well as curbed the enthusiasm of those who were looking susceptible to animal spirits and irrational exuberance.

The NASDAQ Composite’s 10.5% decline from a record high in mid-February through the first week in March served like a cold bucket of water to curb investors’ enthusiasm for a benchmark that had likely gotten ahead of itself in a spate of FOMO (fear of missing out) from the start of the year.

As of last Friday’s close the NASDAQ was up 4.81% from its recent low on March 8 and showing a modest price return of 2.54% from the start of the year. Not bad we’d say considering that the index closed up 43.64% in 2020.

That the equity market move this year has favored cyclicals and value stocks thus far over technology and growth should come as no surprise. Trees don’t grow to the sky after all.

That said, in our view the market move this year is not so much a move away from technology but a move toward value segments of the equity markets that had been out of favor for the last few years. Since the third week of September in 2020 value stocks have regained favor with investors as their appetite has broadened seeking diversification, more attractive valuations and less concentration of technology in portfolios.

Value stocks within the large caps as well as mid cap and small cap stocks historically have been favored in the first part of economic expansions post economic shocks.

A look at sector performance of the S&P 500 as of last Friday shows that of five sectors that have outperformed from the start of the year (with returns ranging from 5.19% to 29.35% versus the S&P500’s 4.18% gain in the same period) five are recognized as being predominantly “value” sectors.

A comparison of the NASDAQ’s performance year to date illustrates that indices’ performance versus other benchmarks including the Russel 2000 (small caps) and the S&P 400 (mid-caps) remains positive even as it underperforms.

For now the stateside economy and economies around the world remain in a transition process working their way toward a post pandemic environment. The process is likely to take some time during which the proverbial noise is likely to obfuscate the signal. We suggest that investors: know what they own, know why they own what they own and have reasonable expectations as to how and why some assets will perform better than others in a given period of time. In our experience patience is a virtue and a discipline essential for successful investing over the long haul.

• We continue to favor equities in the current transitional environment.
• We remain overweight US equities while maintaining meaningful exposure to international developed and emerging equity markets.
• We persist in favoring information technology and cyclicals over defensive sectors as well as exposure across large, mid and small capitalizations.
• For style we prefer a barbell approach with both value and growth in what is likely to remain a low interest rate environment even after yields move higher in response to what we expect will be a sustainable economic expansion stateside that will feed a global economic recovery.
• Among the immediate risks that lie on the landscape are Covid-19 and its variants, the process of economic re-openings stateside and elsewhere around the world that lie ahead, perception of inflation risk, domestic politics, geopolitics and the perennial risks that lie in the realm of the unexpected.