MARKET UPDATE | Cautious Optimism | May 2021
This month, we focus on balancing the market reopening with the uneven path to recovery.
Figure 1: Market Performance as of April 30, 2021
Cautious Optimism: Summary
- The GARP trade continues to be the dominant theme in the markets: equity investors are optimistic about a reopening and resurgence of growth and the need to participate in that growth story, but are investing with an eye towards valuation.
- The pause in the bond market referendum is creating further opportunity for a risk-on market: the Fed’s role in putting a pause in the rise in yields has been key in the short term.
- The inflation story is likely a short-term story but bears watching: while the elements contributing to mounting inflation pressures are short term in nature, there is still some risk of longer term inflation that should not be ignored.
You can read the full Market Update below.
Market Review: Uneven Recovery
Markets in April were influenced by the first quarter earnings results, increasing Covid-19 mutations and macroeconomic variables.
After the blowout of Archegos Capital in March, U.S. markets have bounced back in April on the back of falling unemployment claims and a stellar earnings season. Weekly jobless claims fell from 700,000 to 550,000 during the second week of April and has remained steady since, while the economy added 916,000 jobs in March. The Federal Reserve has continued to reaffirm their current stance holding rates constant at 0.25% and not tapering bond purchases in the near future. This has effectively driven down interest expectations in the near term driving down the intermediate to long end of the yield curve. As the job market continues to recover, people’s income and consumption levels have risen as evidenced by the most recently reported 116.58% earnings growth in the Consumer Discretionary sector. In addition, President Biden has proposed increasing the capital gains tax rate to nearly 40% as well as increasing the corporate tax rate by 7% to 28% along with pushing towards the establishment of a global minimum tax rate wherein companies’ foreign income would be subject to a tax of at least 21%. The markets have taken the tax proposal in stride with little impact to date.
International markets have had a varied performance over the past month. European markets rose to an all-time high over the past month in response to the vaccination drive gaining pace and a comparatively better earnings season. While reopening their borders to vaccinated tourists for the summer season may push equities higher, European markets continue to remain on tenterhooks as investors continue to monitor the reports of blood clots from Astra Zeneca and Johnson & Johnson Covid-19 vaccines and their effect on vaccine rollouts. Japanese markets on the other hand have underperformed over the past month as the government declared a 3rd state of emergency to combat rising cases while their vaccine rollout continues to remain painfully slow with only 0.8% of the population completely vaccinated.
Emerging market remained flat in April, lagging other global indexes owing to the spike in new Covid-19 cases across Brazil and India which resulted from a set of new mutations in the virus and a slow vaccine rollout. As developed economies continue to reopen, demand continues to rise and due to shortage of supply, commodity prices are also rising which both helps and hurts EM nations depending on whether they are importers or exporters. In addition, Alibaba was fined 18.2 billion yuan for monopolistic practices and while investors remain concerned about further anti-trust cases against Chinese technology behemoths, a one-time fine reduces the uncertainty for now.
Intermediate to long term U.S. Treasury yields fell over the past month in response to the Federal Reserve keeping interest rates steady, while Euro benchmarks witnessed yields rising across the spectrum as the European Central Bank indicated phasing out emergency stimulus when vaccinations levels reach a critical point and the economy develops momentum. However, there is increased expectation that central banks across the world might be forced to raise rates to combat rising inflation as evidenced by the Bank of Canada tapering its bond purchases.
WTI Crude Oil prices closed the month at $63.86 per barrel. Scarcity of goods and excess money supply in the markets has led to commodity prices soaring, leading to inflation concerns and gold prices surging from below $1700/ounce to $1781.76/ounce in April. While the Federal Reserve and Treasury maintain that inflation will likely be transitory in nature, the new infrastructure plan announced by President Biden could result in a longer period of inflation driven by stimulus driven demand which could in turn result in a significant rally in prices of raw commodities such as lumber and copper. With home prices at a new record high and demand exceeding supply, the construction industry has been caught flat footed and 1000 board feet of lumber now costs well above $1000, nearly 4 times the pre-pandemic average. Wheat prices also rose to $7.36 per bushel on reports of high demand from China where feed buyers are incorporating more wheat into their feed mix as corn prices remain persistently high and the government has recommended reducing their reliance on corn and soybean. In the cryptocurrency space, Ether rose to an all-time high on interest from major financial institutions around the world in the Ethereum network especially with reports of the European Investment Bank planning to sell digital bonds using this technology.
Going Forward: Cautious Optimism
As the pandemic reopening of the U.S., the U.K. and to some degree the EU are finally starting to take shape, they are all still fraught with ebbs and flows in risk appetite. Faith that the reopening will occur and that there is significant pent-up demand is at odds with the concern that the reopening is not yet global and that supply chain disruptions still create a challenge to the reopening. And, of course, there is the ever-present Darwinian reality that this virus continues to mutate as long as it finds hosts to attack. So, until global heard immunity is reached, the reopening will have challenges. Growing pains will likely continue as job openings grow but recruitment remains challenging. Supply chain disruptions and shipping and logistical challenges also remain top concerns. But, ultimately we are constantly reminded that the pandemic is not yet over and by extension, the pandemic rebound has risk.
Otherwise known as the “view from the bottom” equities are normally the most optimistic part of the market as they are the last in line to be paid. And, this part of the market has flirted with a risk-on shift, but so far, it hasn’t persisted. We continue toThe combination of the reopening trade, concern about inflation and the debt mountain forming have pushed yields up while Fed Chair Jerome Powell continues to talk the bond markets off the ledge. The most recent pledges to maintain easy monetary policy has managed to put a pause in the steady rise in ten-year yields. However, it has not quite broken that trend, but rather sent yields into a holding pattern. This wait-and-see mode could still usher in more pain for the bond markets. Meanwhile, credit continues to experience a goldilocks moment of upgrades with upgrade to downgrade ratio strong in the investment grade space and historic in the high yield space. This is pushing investors to continue to pick up pennies in front of the proverbial steamroller as the underlying fundamentals are not quite in line with the upgrade activity. So, the pressure is on the Fed to keep this party going or risk a return to the bond market referendum on debt, inflation or both. see growth-at-a-reasonable price (GARP) strategies outperform, essentially because investors believe that growth is key at this stage of the recovery, but are unwilling to invest into significantly overpriced segments of the market. We see this continuing until key segments of the Emerging Markets like South Africa, Brazil and India and poorer nations in general get control over the spread of the pandemic. U.S. equities has traded well ahead of international markets while developed market equities have significantly outpaced EM equities. We see this continuing until vaccines reach the rest of the world. That said, we also see unlocked value in the international, non-China segments of the economy as those economic openings are not yet priced into the markets.
There are several reasons that inflation remains a concern in the markets. First, the short-term shortage of workers resulting from fear of infection, lack of child-care and in-person school access and the ability to ride out the next few months of jobless benefits is creating challenges for companies trying to reopen. Second, the shortage of commodities resulting from exogenous factors such as the drought in Taiwan exacerbating the shortage of semiconductors to COVID-related copper and nickel mine closures has driven raw goods prices up and will likely continue to do so until commodity exporting nations can effectively and fully reopen. Finally, logistical logjams from shipping to trucking add to the risks faced by companies in the reopening. So, the road to reopening is hardly clear or simple and will likely take longer than expected, driving up prices in the meantime and keeping inflation fears alive and well, if only for the short term. And, while the likelihood of longer-term structural inflation remains low for now, there are some policy initiatives that could certainly change that outlook including changes to minimum wage policy and a push towards increasing collective bargaining power by labor unions.
We continue to overweight small cap over large cap in the U.S., despite a breather in March and continue to overweight value and GARP versus growth in the great quality rotation.
Past performance is not an indication of future performance. The information provided in this newsletter is for informational purposes only and should not be considered investment advice or a recommendation to buy or sell any types of securities. There is a risk of loss from investments in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Asset allocation and portfolio diversification cannot assure or guarantee better performance and cannot eliminate the risk of investment losses.
The information contained herein reflects Lido’s views as of the date of this newsletter. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. Lido has obtained the information provided herein from various third-party sources believed to be reliable, but such information is not guaranteed. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Lido is not responsible for the consequences of any decisions or actions taken as a result of information provided in this newsletter and does not warrant or guarantee the accuracy or completeness of this information.
The MSCI All Country World Index is designed to represent performance of the full opportunity set of large- and mid-cap stocks across 23 developed and 27 emerging markets. As of November 2020, it covers more than 3,000 constituents across 11 sectors and approximately 85% of the free float-adjusted market capitalization in each market. The index is built using MSCI’s Global Investable Market Index (GIMI) methodology, which is designed to take into account variations reflecting conditions across regions, market cap sizes, sectors, style segments and combinations. (Source: MSCI)
The Russell 3000 Index measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market. (Source: Russell)
The Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 represents approximately 92% of the U.S. market. (Source: Russell)
The Standard & Poor’s 500® is a market value weighted index that includes the 500 leading U.S. based companies and captures approximately 80% coverage of available market capitalization. (Source: S&P Global)
The Dow Jones Industrial Average™ was introduced in May 1896, is a price-weighted measure of 30 U.S. blue-chip companies. (Source: S&P Global)
The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. (Source: Russell)
The MSCI All Country World Ex U.S. Index is market-capitalization-weighted index maintained by Morgan Stanley Capital International and designed to provide a broad measure of stock performance throughout the world, with the exception of U.S.-based companies. The MSCI All Country World Index Ex-U.S. includes both developed and emerging markets. (Source: MSCI)
The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada. The Index is available for a number of regions, market segments/sizes and covers approximately 85% of the free float-adjusted market capitalization in each of the 21 countries. (Source: MSCI)
The MSCI Emerging Markets Index captures large and mid-cap representation across 27 Emerging Markets countries. With 1,397 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. (Source: MSCI)
The Barclays U.S. Universal Index is an unmanaged index comprising U.S. dollar-denominated, taxable bonds that are rated investment grade or below investment grade. (Source: Barclay’s)
The Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency). (Source: Barclay’s)
The BofA ML U.S. High Yield Master II Index tracks the performance of U.S. dollar denominated below investment grade rated corporate debt publicly issued in the U.S. domestic market. (Source: BofA Merrill Lynch)
The Bloomberg Commodity Index is a broadly diversified commodity price index distributed by Bloomberg Indexes. It tracks the price of furutes contracts on physical commodities on the commodity markets. (Source: Wikipedia)
The Alerian MLP Infrastructure Index is a composite of energy infrastructure Master Limited Partnerships (MLPs). The capped, float-adjusted, capitalization-weighted index has 25 constituents that earn the majority of their cash flow from the transportation, storage, and processing of energy commodities. (Source: Alerian)
The S&P GSCI Gold Index, a sub-index of the S&P GSCI, provides investors with a reliable and publicly available benchmark tracking the COMEX gold future. The index is designed to be tradable, readily accessible to market participants, and cost efficient to implement. (Source: S&P Global)
The BofA ML 3-Month T-Bill Index is an unmanaged index that measures returns of the three-month Treasury Bills. It consists of a single issue purchased at the beginning of each month and held for a full month. (Source: Lido)
The HFRX Global Hedge Fund Index is designed to be representative of the overall composition of the hedge fund universe. It is comprised of all eligible hedge fund strategies falling within four principal strategies: equity hedge, event driven, macro/CTA, and relative value arbitrage. (Source: HFRX)
The Dow Jones Real Estate Index is designed to track the performance of real estate investment trusts (REIT) and other companies that invest directly or indirectly in real estate through development, management, or ownership, including property agencies. (Source: S&P Global)
LA21MUBG03 — March 2021 Market Update