Led by macro cap technology stocks and long-term government bonds, financial markets added to their year-to-date gains during July 2021 amidst growing concerns that, not only has the rate of acceleration in economic growth peaked, but it is transitioning to markedly slower levels. This note will table some thoughts germane to that discussion, but first let’s recap last month. As can be seen from the 18-month graph below, the strong correlation between falling yields and the outperformance of the tech-dominant NASDAQ has continued of late.
When we published our 2021 Market Lookahead commentary (December Commentary) in early January, it was an easy call to be bullish on stocks. The pitch was simple and the majority of buy and sell-siders shared similar outlooks. Unprecedented stimulus, albeit higher but still low interest rates and an expected flow of funds into stocks partially supported by declining volatility. With the S&P 500 having closed last week at 4,352 the outlook call gets tougher for long-only managers and especially sell-side equity strategists who have a propensity to be bullish. Interest rates remain surprisingly low and, as can be seen from the right side of the first graph, declining volatility (yellow line) continues to boost the capital allocation to stocks (white line) for traders targeting portfolio volatility of 10%.
With America shifting to a ‘getting back to normal’, no mask stance, investors began May 2021 exhibiting a ‘risk on’ attitude, enabling stocks to advance strongly out of the gate. As can be seen from the 1st graph below, the general trend of the past seven months (since Pfizer’s vaccine news of Nov. 9th) favouring value, cyclical and ‘re-opening’ stocks, continued during early May. By mid-May, the combination of a weak U.S. jobs report and hotter-than-expected pricing data south of our border, triggered a rethink among investors, catalyzing the 2nd factor reversal year to date. Judging by the lack of reaction in bond yields shown in the 2nd graph below, it’s apparent that, for now, investors chalked the miss on jobs to timing and have given the Fed a free pass on its ‘transient’ attitude towards inflation. Most equities recovered, though value bettered growth, yet lingering investor uncertainty made a sustainable rise through 4,200; a tough nut to crack for the S&P 500 through the time of writing of this note.
April 2021 featured a continuation of the year-to-date grind higher in stocks, enabling most North American equity indices to reach all-time highs. The catalyst for this strength remained ongoing policy stimulus and the re-opening of the U.S. economy. Meanwhile, this rally has masked significant factor volatility, which in turn has driven rising dispersion between the returns generated by different investment styles. Fortunately, given that security selection at Forge First is driven by a company’s ability to generate free cash flow, our funds are largely agnostic towards factor rotation and have been able to maintain net returns in the middle of the proverbial fairway.
It’s not surprising that Q1 of 2021 was good for equities, the question is whether the optimal conditions that drove stocks higher will move from the front windshield to the rear-view mirror during the remainder of this year. Before we assess that probability, let’s review the quarter that marked the anniversary of COVID-19.
Another action-packed month in markets saw bond yields spike, oil soar and all North American indices deliver solid returns despite the sea of red during the last week of February. Once again, the funds at Forge First profitably navigated these stormy waters.
Last month’s 2021 Market Lookahead commentary (December Commentary) included the text, ‘we continue to be of the view that the near-term setup for stocks remains good given the ‘market nirvana’ combination of open-ended stimulus and the pending recovery in earnings. While we expect cyclical and value-oriented stocks to outperform ‘high growth, momentum’ stocks during the next several months, neither do we foresee interest rates climbing enough to cause a stampede away from these heavily weighted securities.’ Our message today remains the same.
Happy, or should we say Hopeful, New Year has rarely seemed such an apt phrase. Obviously 2020 was a horrendous year for the majority of people, hence it’s good to have the last 10 months in the rear-view mirror. Entering 2021, hope that both society and the economy will evolve towards normalization in as timely a fashion as possible is a widespread theme. Ironically, it was a record year for financial assets, as Wall Street feasted while the rest of the world suffered. Governments everywhere tabled previously inconceivable amounts of fiscal stimulus, while monetary authorities definitely delivered on Draghi’s maxim of “doing whatever it takes”. Almost instantaneously this combination of adrenalin, estimated by Cornerstone Macro to equal 32.9% of global GDP, transformed the outlook for financial markets. In our minds, it was monetary action that mattered most for stocks.
What a month November 2020 turned out to be! While point-to-point bond yields were flat, all 50 global equity indices tracked by S&P Global Markets showed gains, fueled by the market’s transition from ‘Merger Mondays’ to ‘Vaccine News Mondays’.