Monthly Market Muhsings - February 2021
Markus Muhs - Mar 01, 2021
If February 2021 can be summed up in three words, those words are Rotation, Bonds, and Inflation
Over the years my monthly market updates have evolved from me simply recounting what happened in the markets in the past month, to more of a “Muhsing” (obviously a play on the word “musing” if you didn’t catch that) that goes beyond the mostly personal finance-related theme of my other blog posts.
Obviously, you can see the numbers in the table below and I don’t need to list them all to you in paragraph form, but what are the highlights and what lies behind those numbers?
Yes, markets were up across the board in February, and each of the North American indices I track in my drawdown table hit new all-time highs, though we did see some bumpiness at the end of the month, as you can see from their current drawdowns.
If February 2021 can be summed up in three words, those three words are:
From growth into value. While the S&P 500 did a decent 2.6%, you might notice above that the Nasdaq, that’s been leading the way for so long, had a pretty meager showing. This is a very growth-heavy index. The S&P 500 Value index, not shown, actually did 5.7% in Feb, and small caps you can see above also had a good month. February was very much like November; the first month we saw this rotation at play. Growth was flat for a change, while previously underperforming value and small caps led the way.
The graph below shows how each of the above-mentioned factors performed during the month of February in relation to the S&P 500.
I will be talking about bond yields next, but these things kind of flow into each other. An environment of possibly rising rates, and tightening monetary policy bodes better for cash-machine value stocks than it does for capital-hungry growth stocks. In any case, value’s time is long overdue.
U.S. and Canadian long-term bond yields have “skyrocketed”, relatively speaking. Most of the attention’s on the U.S. 10 year of late, but to change things up I’ll highlight Canadian yields, below.
I did a 3-year chart of the 5, 10, and 30-year GoC bond yields to demonstrate a few things. One is that we can calm down, we’re not heading into 1980 style interest rates any time soon. We’re talking about coming out of the rock bottom they have been at since the pandemic hit; it’s only the speed at which they've recovered that surprised many.
The 5 year is one that borrowers should take note of, as there typically is a strong correlation between 5-year mortgage rates and the 5-year GoC bond yield. Lock in your rate if you’re planning to buy this spring/summer! It’s really only back to early-March levels though, having risen from below 0.5% to 0.88% (today’s 5-year GIC rates are around 1.6%; not bad by comparison, though still a near-guaranteed money-losing proposition after tax and inflation).
The 30-year is actually right back to January 2020 pre-pandemic levels. All in all this movement in rates is actually a GOOD symptom of a strengthening economy. Further to that, you’ll see a couple instances in the last 3 years when the yield curve went FLAT (illustrated here by way of the lines joining together). Flat yield curves tend to be precursors of a weakening economy; it’s the bond markets saying they don’t believe yields will rise, so they assign the same interest rate to a 5, 10, and 30-year bond. Today we’re seeing a pretty steep yield curve, with the bond markets predicting rates to generally go up.
The markets of course always treat rising rates as a bad thing, initially. Ultimately though, the stronger economy that those rates predict (and bond markets tend to be way more on the ball on these things than stock markets are) ends up being reflected in stock values.
What I’d caution investors about though is that we very likely are in a secular bear market for bonds. That is, we just exited a 40-year bull market during which rates generally trended down from 1980 to 2020, and now could see decades of rates generally trending upward (causing bond values to go down). This affects other assets as well, such as “bond proxies” like utility stocks. It also could mean that the bond component of your balanced portfolio, which gave you a nice counter-balance to equity risk and generally yielded you a return only a bit lower than stocks, can now become a major anchor on your portfolio.
I’m not saying dump bonds, because we can’t predict any of this, and a market crash and return to declining rates (just see in the above graph what bonds did in just the last few days of February, when stocks took a tumble), but set yourself the right expectations and diversify your bond factors just as you do your equities (Rational Reminder did a good podcast on this last week).
Two numbers that really pop out on the market return table are those for oil and industrial metals. WOW! Oil is actually back to pre-pandemic highs and industrial metals, broken down a bit in the graph below into three of the major ones, have been on a steady incline since the middle of last year.
Obviously, all that quantitative easing, with governments around the world effectively “printing” money and putting it right into their citizens’ bank accounts, is going to have such an effect. Add to that the fact that, globally, consumers have been spending most of the money that they haven’t saved (or invested in meme stocks) on goods (ie: appliances, cars, new homes, home renos, Peloton bikes) as opposed to services (ie: vacations, restaurants, concerts).
Commodities are finally in high demand, and occasional Covid shutdowns in some mines here and there haven’t helped the supply situation. If I can make a prediction here, and I usually try to avoid doing this: I think we still haven’t seen the end of this. The words “commodity supercycle” are being thrown around, and a return to travel after much of the oil industry has been holding back on new drilling could exacerbate a potential oil shortage. Other commodities too remain in demand as manufacturers race to replenish inventory of those items in high demand (when I replaced my dishwasher last fall, Lowe’s was running low on stock of many models) while others replenish inventories that were allowed to run low in preparation for a recession.
Anyway, inflation is the most important thing we need to keep an eye on. It ruins financial plans. Mostly it’s the main cause of the end of economic cycles. People blame the housing market or banking industry on the Great Financial Crisis of 2008, but initially, it was inflation caused by commodity prices; such as when oil went up to $140/barrel and when China was eating up much of the world’s copper and iron in their expansion. Here in Alberta I think we were ticking 6% inflation back then and the response from central banks everywhere was to raise rates to rein it in, leading to tighter lending, less capital available for growth, and that’s how it all went down.
Latest inflation figures still aren’t alarming just yet, and again those longer-term bond yields are just predictive that central banks are likely to hike at some point from zero to more normal low rates, like we've seen through most of the past decade. Perhaps they’ll even keep rates low for a very long time, as they did post-WW2; neither governments nor mortgagors can afford too much of an increase. The cost of keeping rates ultra-low, of course, can be flare-ups in inflation, and I wouldn’t want to be long on cash (whether savings, GICs, bonds, or anything else with a dollar face value) in such an environment.
Remember, as I mentioned in one of my posts last year: all the debt being accumulated during the pandemic, just as was the case after WW2, will never be paid back. It’ll get inflated away. Don’t let your retirement nest egg get inflated away alongside it.
Investment Advisor & Portfolio Manager
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All of the above graphs were generated with the free version of Koyfin.