2 Minute Market Update 10th January 2021
Markets were resilient in the face of US political upheaval and a BlueWave was seen to be supportive of the Reflation Trade
10 year bond rates pushed in the US and Australia pushed upwards past 1% .
Value outperformed growth but US tech staged a late come back after falling sharply earlier in the week.
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The Week That Was
In this weekly update we presume that our audience expects us to observe events in world markets and analyse the impact on portfolios past and present, rather than pontificate too much on geopolitics and what may or may not happen in the future. However, the events of last week make the distinction more difficult. Only the most jaundiced observer would maintain that this is ‘just politics’ or that there will be no lasting impact. At any rate we haven’t come across any pundits in that camp so far. So whether the world changed or whether the investing world shifted dramatically because everyone thinks the world changed is perhaps a moot point.
The delayed cresting of a Blue Wave was always going to crystallise the Reflation Trade to some degree (higher rates, a value rotation, support for clean energy and infrastructure spending amongst other themes). We could see subtle signs as the polling start to shift in December and more immediately as the market began to sniff the possibility of a Democrat controlled Senate early last week. Now, the storming of Capitol Hill seems to have handed the Democrats a moral imperative that razor thin margins had thus far denied them and, for now at least, hamstrung the US opposition-to-be narrative to an even greater degree. As we detail in the market commentary below the market is seeing the glass as half-full and the probabilities of a good 2021 for markets may have increased. Thereafter, things get more complicated as we consider the longer-term funding and inflation/interest rate implications of the stimulus that is going to be applied to the largest economy in the world and probably copied elsewhere. Even in the near-term the range of outcomes has increased uncertainty and risk. The stylised distribution below graph depicts this.
Note that the shift in variance is biased to the ‘what if something goes wrong’/left-hand tail of the the distribution. This is primarily because we think the right hand side of the distribution is self-limiting - if the economy is strong enough to suggest another 30% surge in markets then rate expectations will be much higher which would hurt both markets and ultimately the economy Unfortunately the events of last week may hasten the acknowledgement of the inevitable - the outlook for a debt laden global economy is skewed with limited upside and much that can go wrong tp the downside. That said, we must act on probabilities rather opinions or single-point estimates and the most likely outcome remains positive in the near term. So in summary, the events of last week mean ‘more long but more cautious’.
Back to the markets of last week. The main event was bond markets - throughout the week inflation and hence rate expectations increased and US 10 year rates marched passed the psychologically important 1% barrier ending up just over 1.1% here and in the US. For someone investing in Government Bonds or very high grade fixed interest corporate bonds that meant a modest loss of 1% while longer duration government debt (10 years or more) fell in value by 5% or more. Floating rate high grade corporate debt and relatively risky high yield, or junk bond, securities were flat. The distinction between fixed vs floating rate debt maybe become more important in the future.
In equity markets Energy was the main beneficiary of the Blue Wave/Reflation trade, up by 10%. By market cap this is mostly oil stocks but it is notable that many renewables were also by by an even greater amount. Financials and Materials were also up by 5% and the only slightly negative contribution was from IT. More revealing though was the shift between so called value and growth stocks. As we flagged earlier in the week large US tech stocks sold off sharply during the Capital Hill siege but interestingly many of them bounced back to catch-up with the rest of the market by the end of the week. This rebound was concentrated in some of the more well known household name tech stocks which may imply a Robinhood/retail effect. Tesla in particular was up 20%, making Elon Musk the wealthiest billionaire in the world, although this may also have been Energy related. Elsewhere in the world, and amongst smaller US stocks, the value/growth rotation persisted throughout the week - global ex-US growth stocks were up by 1% while value was up by 4%. The UK and China were the best performing national indices (up 6%) while Europe, the US, and Japan all ended up by around 2%. In Australia modest gains amongst banks and materials offset weaker performance elsewhere. In particular, the prospect of higher interest rates was most likely responsible local REITs retreating by around 2%. Within commodities gold and silver were down slightly but pretty much everything else was up strongly led by oil and natural gas.