January was a very interesting month in the markets. Aside from the GameStop round trip, as detailed in a recent blog post, the month was interesting for a number of reasons. Coming off a hot December and a red-hot November (as discussed in this blog), stock began the month with a bang (MSCI ACWI up 3.7% through January 21) but ended the month with a whimper (MSCI ACWI down 0.4% for the entire month), with the global markets falling over 4% during the final six trading days of the month. That said, equities did manage to outperform bonds, with U.S. bond indices falling 0.7% and global bond indices falling 1.6% during the month. This marks only the fourth month since the bull market began in 2009 (i.e., 143 months) in which both stocks and bonds fell, yet stocks managed to outperform bonds (the other three being November 2010, June 2015, and October 2016).
As has been the case with this bull market, any time we have some turbulence, investors begin to get concerned about “the big one.” We are here to tell you that the bumpiness in late January has all the hallmarks of a typical pullback in a bull market, based on historical precedent. Of course, history could be “different this time,” but it is rarely wise to position’s one portfolio that way. In the big picture, the market is extremely broad. And as we have said frequently, broad markets are strong markets. To put a context on this, at this moment, over 90% of stocks are above their 200-day moving averages. For context, at the peak of the internet bubble in March 2000, only 35% of stocks were above their 200-day moving averages, and they were basically all in two sectors – technology and telecom. Beating the same drum that we have beaten over the recent months, today is a very different picture. We are seeing simultaneous new 52-week highs in stocks in the Technology, Materials, and Energy sectors, which is quite a feat since Technology is thought to excel in more deflationary environments while the latter two have typically outperformed in inflationary times.
So, what do we make of this? The equity market and bond market do seem to be challenging the Federal Reserve. Chair Jerome Powell continues to say, “we’re not even thinking about thinking about raising rates” and insists that short-term rates will stay low into 2023. Yet the equity market is up over 20% since then, and the Fed language remains unchanged. This type of market action in response to Federal Reserve official policy is not unprecedented in recent times. In December 2015, chair Janet Yellen said, “I feel confident about the fundamentals of the U.S. economy,” yet the market declined over the subsequent three months. In October 2018, chair Powell said, “We’re a long way from neutral at this point,” and yet again the market declined over the subsequent three months, this time on the order of 20%. Lest we think the challenges are restricted to the equity markets, bond markets look to be issuing a challenge of their own. The U.S. 10-year Treasury yield is now 1.2%, up from the low of 0.5% merely six months ago. Similarly, the U.S. 30-year Treasury yield is 2.0%, up from the low of 1.2% merely six months ago. Rates are rising and breaking out as the recent Manufacturing PMI of 58.7 represents a strong reading historically, in the 90th percentile.
Broadening our scope to look globally, not just domestically, sentiment continues to run hot, which points to potential weakness in the coming months with a necessary consolidation or correction. Historically, this would also coincide with the first few months after the change in the White House administration, as the market adjusts to the new policy before resuming higher. Despite the potential for some bumps along the way, we see many signs of a global rally that is sustainable over the longer term.
- Bond yields are breaking out everywhere, not just in the U.S.
- Global yield curves continue to steepen.
- Credit, typically a canary in the coal mine for equities, continues to look good. Globally, spreads continue to decline in energy, airlines, consumer discretionary, and the other ground zeros of the Coronavirus pandemic.
- Oil continues to rebound, with both WTI crude and Brent crude approaching the levels from which they collapsed in the Coronavirus market panic. What makes this even more impressive is the price strength has occurred during a month in which the dollar has begun to rally.
Touching on the dollar rally, signs point less to a sustainable bottom and more to a countertrend rally in the context of a greater downtrend. Currencies are no different than any other assets in a downtrend in that short-term selling can exhaust itself and rallies occur as short sellers begin to cover their short positions to harvest some profits. How much more to go is, of course, uncertain, but the likely ramifications are going to impact foreign stocks more and industries more levered to a weaker dollar such as industrials and multinational companies. This should be a tailwind in the near term for Growth stocks relative to Value stocks until the rally is over and the dollar resumes its decline, which is likely one reason why Growth stocks have quietly outperformed Value stocks in each of the last two months.
Overall, we continue to see the global equity opportunity set expanding, as international equities become more appealing. While our models are not yet signaling International Developed equities to be included in unconstrained allocations, they are moving closer to supplementing the Emerging Markets position we have already taken on. Additionally, we continue to see the potential for outperformance in our U.S. Energy allocation, which should not be mistaken for a secular outlook of strength in the oil and natural gas patch, but rather as an allocation to a sector that became absurdly undervalued relative to its intrinsic net worth and then reversed when the market recognized the value. In other words, the investment is predicated on a sector that was sharply undervalued at the time of entry rather than on any thoughts about the long-term future of the energy sector.