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What the Market?
One doesn’t need a degree in psychology to see that increasing bond yields are giving Mr. Market anxiety. LL Cool J may not call it a comeback, but the U.S. economy certainly will. With recent data suggesting the market is returning to growth mode, Mr. Market is afraid of a potential spike in inflation and is considering getting out of the growth game (for now). Is Mr. Market mimicking LL’s 2 hour retirement from the biz or is shit really about to hit the fan?
How come?
He said what!? The Fed Chairman’s Speech last week reiterated the Fed’s commitment to maintaining low interest rates and suggested that there may be more inflation on the horizon, particularly with a $1.9T economic stimulus package. Equity markets dropped on the news Thursday, as the Fed seems unphased by rising yield rates and inflation expectations, building up suspense for the Fed’s meeting mid-March.
Will yields finally yield? Yields continue to tick upwards as expected, rising to their highest yield in over a year. That’s okay! Real bond yields are still negative and may continue to rise. To investors, bonds provide an alternative vehicle to secure future cash flows with minimal risk. As bond yields rise, the price of bonds drops and presents greater competition to comparatively riskier assets. Rising yields increase the cost of capital and may erode the value of expected future cash flows for speculative and growth stocks with lofty valuations, explaining the recent pullback across speculative sectors. The issue here is not that yields are rising, but at the speed at which they are doing so.
The economy is healing: The February employment report indicated that 379K jobs were added in the past month! The vast majority of the jobs came from the hospitality sector – one of the biggest reopening sectors. Additionally, factory activity hit a three-year high, with construction spending surging to record highs. The report was certainly a breath of fresh air; however, as 2020 showed us, a strong economy does not always reflect strong financial markets and vice-versa.
What’s an investor to do?
Investor mindset:
What goes up, must come down. Rallies cannot go on forever and pullbacks are actually a healthy reset for the market when valuations are astronomical and illogical (as they have been for the last few quarters). The question now is whether prices will continue to drop or whether it’s time to double down on some bargain prices. Stay calm, and monitor the economy closely.
Portfolio management:
Once upon a time tech and speculative stocks were considered a high-risk diversification play. As investors have grown to better understand these high-growing sectors, speculative stocks have become a mainstay in many portfolios while exposure to value stocks and traditional sectors (e.g., financials, energy, industrials) has dropped. Value and growth stocks often take multi-year turns leading the market, and it’s possible that value stocks may be stepping up to the plate. As yields continue to rise, another stimulus package arrives, and vaccine development accelerates, it’s a good time to build positions in reopening and consumption-driven sectors of the real economy (e.g., energy, cyclicals).
Keep an eye on the economy
The February CPI report will provide insight into the inflation fears which have not yet actualized. Released Wednesday
Consumer sentiment figures will provide depth into how Americans feel about the first weeks of the Biden Administration and the impact of the last stimulus package and the upcoming one. Released Friday
The Curious Investor:
Operation Twist - Volume III: No, it’s not a plan to save Oliver from the orphanage, but it is a plan to “flatten” bond yields and put downward pressure on long-term interest rates. The 10-year Treasury note yield is the benchmark for interest on loans, credit cards, mortgages, furniture, and numerous other products. Lower interest rates tend to encourage consumer spending and boost economic activity.
To accomplish this, the Fed purchases long-term bonds (driving demand and raising prices, and thus lowering yields) while simultaneously selling short-term bonds (increasing supply and lowering prices, and thus raising yields). Operation Twist is a more market-friendly monetary policy approach that does not expand the Fed’s balance sheet. The Fed has used Operation Twist twice before in 1961 and 2011 to lower yields and help boost economic activity, and recent movements in long-term bond prices have sparked rumors that the Fed may do it again. Although it is too early to call, the Fed is monitoring the bond yield curve closely and, should bond yields continue to rise, there will likely be an update in Mid-March from the Fed.
Reopening and value exposure (Disclosure: WTM is long DIS & NKE): The ongoing economic rebound will likely give a short-term boost to earnings in beaten down sectors; potentially stealing some thunder from tech and high-growth stocks (especially in the context of rising bond yields). As the economy recovers and investors cycle out from growth to value positions, there is still time to build positions in reopening and/or cyclical positions. Consider:
No notable earnings this week
Economic Calendar:
Monday: Chinese trade balance, Japanese Leading Economic Index and GDP figures, Eurozone investor confidence, Bank of England Governor speech
Tuesday: U.K. Retail sales, Eurozone revised GDP figures, U.S. Redbook Index
Wednesday: Chinese CPI and FDI figures, U.S. CPI figures and monthly budget statement
Thursday: Eurozone interest rate decision and monetary policy statement, U.S. Jobless claims
Friday: U.S. Consumer sentiment figures and producer price index, Eurozone industrial production
If you didn’t know, now you know
Large anti-government protests have started in Lebanon as the nation’s currency hit a record low. Long before the bombing in August, Lebanon has been facing an economic crisis that has some declaring the country a failed state. In Lebanon, the minimum wage is 675K pounds (~$67/month); whereas prior to the 2019 anti-corruption protests, the minimum wage was $450/month. The majority of the population now lives in poverty with frequent blackouts and fears of food shortages.
This summary only covers the surface of the conflict. To read more, click here.
What we’re vibing:
Mexican Cooking Masterclass by Gabriela Camara: For those cooking aficionados, or lovers of Mexican cuisine, world-renowned Chef Gabriela Camara provides a glimpse into the art of preparing innovative and traditional dishes.
WandaVision on Disney+(Disclosure: WTM is long DIS): If you’re a fan of the Marvel movies and haven’t watched WandaVision yet, what are you doing with your life? This show is awesome, and a great expansion of the Marvel universe that lets us dive deeper into the characters that don’t have their own movies.
Peptides and nasal sprays that stop COVID may be on their way
CVS will vaccinate teachers under 50 in Florida after the Governor says no
Teen sets up fake cosmetics site so women can report domestic violence while pretending to shop
Looking for more?
Resources
WTM Mentions Performance Tracker
A content guide to investing (books, books, books!)
Disclaimer
This writing is for informational purposes only and the author/s undertake/s no obligation to update this article even if the opinions expressed change. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services in any jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. The author/s expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.