Wealth Management — January 27, 2021
- US stocks traded lower on Wednesday as the S&P 500 declined 2.6% to close at 3,751. With the sell-off, the index is now down 0.1% year to date.
- The S&P 500 recorded its steepest one-day loss in three months as volatility returns to Wall Street. While there was no single catalyst to explain the weakness, a number of factors likely contributed to Wednesday's decline. 4Q earnings season, the January FOMC meeting and the surge in high-short interest stocks all were topics of interest during the trading session. However, while these events likely played a part in the sell-off, some consolidation may have already been due given the extent of recent market gains, and that is likely what we are seeing this week.
- All 11 S&P 500 sectors finished the session lower, with Energy (-1.4%) and Real Estate (-1.4%) outperforming the broader market, while Consumer Discretionary (-3.1%) and Communication Services (-3.8%) lagged the broader market.
- Rates were lower across the curve, with the 10-year Treasury yield falling to 1.01% as of the 4 p.m. equity market close. Gold was 0.5% lower, while WTI oil was flat at nearly $53 per barrel. The US dollar strengthened modestly in the trading session, as measured by the US Dollar Index.
US stocks fell 2.6% on Wednesday as the S&P 500 recorded its sharpest one-day drop since October 2020. A number of factors likely contributed to the sell-off, though markets may have already been susceptible for some consolidation given the extent of recent market gains; in fact, all three of the major US equity averages had recorded new all-time highs within the past week. A busy week of earnings results has given markets much to digest, with nearly 40% of the S&P 500 by market cap offering 4Q results. While earnings have largely come in above expectations, stock reaction has been mixed, perhaps suggesting the recent rally across markets has left a higher bar and even strong results are not being bought. Markets also seemed fixated on the surge of stocks with high short-interest this week, which perhaps has triggered some investor caution that speculative excesses may be building. Finally, Wednesday also saw the January FOMC meeting; while the rate decision went as expected with the committee offering few changes to its outlook, equities did continue to sell off into the close of the session. While Wednesday's near 3% sell-off may be concerning, markets are coming off of a strong upward trend in recent months that has seen few significant drawdowns; some consolidation should be expected and the sell-off likely reflects that with the S&P 500 now back to flat on the year to date.
Record and unprecedented stimulus from both the Fed and Congress has unleashed a V-shaped recovery in global trade, manufacturing, goods retailing, and housing. That momentum, coupled with the resolution of the US Presidential election and much better-than-expected initial trial outcomes for COVID-19 vaccines, has lifted equity markets to new all-time highs. Although investors are correct to be concerned about index level valuations, which have reached multi-decade extremes at more than 22x forward earnings, the economic and profit dynamics in 2021 could support another 5%-10% gain to 3,900 for the S&P 500. Another round of fiscal stimulus, continuing Fed accommodation, and swelling pent-up demand for consumer services, may also support economic growth acceleration to 5%-6% real GDP, with inflation rebounding to more than 2%, a scenario that should support 27% year-over-year profit gains. However, optimal navigation of this burgeoning new business cycle will require care as Treasury rates are likely to move higher, creating a headwind for long-duration assets. In stocks, our preferences remain focused on quality and valuation support, attributes that remain in small caps, international stocks and cyclicals, including financials, which should benefit from the steeper yield curve. Dollar weakness is likely to continue as policy choices are debasing and relative growth outside the US becomes more compelling, supporting the case for emerging markets and commodities. In fixed income, the challenge is two-fold: Generating sufficient income, while also preserving capital, requires a diversified and active exposure, with our preference toward a mix of corporate credit (IG and HY), preferreds, leveraged loans, asset-backed securities, including select mortgage-backed, and dividend-paying stocks. Capital preservation and portfolio hedging from equity volatility may be achieved with a combination of cash and ultra-short duration instruments, and absolute return hedge funds. Real assets like gold, infrastructure and real estate for inflation support should be bought opportunistically.
Market data provided by Bloomberg.
Dow Jones Industrial Average (DJIA): A price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry.
NASDAQ Composite Index: A broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market.
S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.
US Trade-Weighted Dollar Index: A weighted average of the foreign exchange value of the US dollar against a subset of the broad index currencies that circulate widely outside the US.