Wealth Management — January 29, 2021
- US stocks traded lower on Friday as the S&P 500 declined 1.9% to close at 3,714. With the sell-off, the index is now down 1.1% year to date.
- With Friday's sell-off, the S&P 500 ends the week down 3.3%, marking the index's worst week in nearly three months. Volatility returned to Wall Street this week as markets had much to digest, between a heavy economic data calendar, 4Q corporate earnings reports and a number of developments on the virus and vaccine front. Perhaps adding to this week's turbulence, a dramatic rally across highly shorted stocks appeared to cause ripple effects across markets more broadly. While equities end the week sharply lower, 10-year Treasury rates were flat on the week.
- All 11 S&P 500 sectors finished the session lower, with Utilities (-0.6%) and Health Care (-0.8%) outperforming the broader market, while Information Technology (-2.4%) and Energy (-3.4%) lagged the broader market.
- Rates were higher across the curve, with the 10-year Treasury yield rising to 1.07% as of the 4 p.m. equity market close. Gold was flat, while WTI oil was slightly lower to nearly $52 per barrel. The US dollar strengthened modestly in the trading session, as measured by the US Dollar Index.
US stocks fell on Friday, with the S&P 500 declining 1.9%. With the sell-off, the index finishes the week 3.3% lower, which marks the worst week for the index since October of last year. A week filled with news and data updates brought volatility back to Wall Street, with the CBOE Volatility Index (VIX) spiking more than 50% on the week. While equities sold off, 10-year Treasuries were flat on the week; the relative resilience of Treasury yields perhaps suggests this week's equity sell-off is more technical in nature, as opposed to being reflective of any change in fundamentals. To that end, equity markets may have been due for some consolidation given the extent of recent gains, with all three of the major averages having recorded new all-time highs as recently as last week. While no single catalyst can be pinpointed for this week's reversal, a number of factors likely contributed to the decline. On the fundamental front, markets had much to digest between a busy slate of economic data reports and 4Q corporate results; while generally these releases came in as expected or better, market reaction was mixed. On the technical front, a surge in several highly shorted stocks appeared to drive the spike in volatility and likely contributed to the sell-off in equities more broadly. Finally, markets continue to weigh the risks posed by the pandemic, with focus this week on new variants of COVID-19 as well as updates on new vaccines and distribution efforts.
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.
VIX: This is a trademarked ticker symbol for the Chicago Board Options Exchange Market Volatility Index, a popular measure of the implied volatility of S&P 500 Index options. Often referred to as the fear index or the fear gauge, it represents one measure of the market’s expectation of stock market volatility over the next 30-day period.