Published January 15, 2021
After a sharp two year decline in interest rates which saw the 10-year U.S. Treasury yield plunge from 3.0% all the way down to 0.5%, rates have broken back above 1.0% and appear headed well higher.
The yield curve has also steepened, a condition where longer-term interest rates are rising faster than short-term rates. This move suggests higher expected economic growth and/or inflation out in time. This, while the Federal Reserve continues to talk down short-term interest rates and preach a cautious economic outlook.
What has happened is that the economic recovery baton is being passed from monetary policy to economic policy as the incoming Biden administration tees up another round (or two) of massive stimulus spending. The Fed has done its job, being extremely aggressive early in the pandemic to soothe rattled markets. Now, the economic recovery, which has shown signs of stalling recently, appears to need a more substantial shot in the arm as we wait for the vaccines to work their way through the population and restore widespread confidence in public gatherings. At least that’s the message the markets are receiving, and embracing, at least for now.
On the inflation front, adding to the expected inflationary expectations from the stimulus, copper and other commodity prices have been surging, a move very reminiscent of the post-financial crisis rebound (blue arrows below).
This move has potentially put in a multi-year bottom for emerging market stocks relative to the S&P 500. The chart below shows the underperformance of emerging markets over the past decade. Too early to say that this trend has turned for good. A key question remains as to whether the U.S. dollar will bounce back from its slumber now that interest rates are rising (rising rates equal a stronger currency, other things equal). A down-trending dollar helps fuel strength in overseas markets as well as commodities, a double dose of goodness for emerging market stocks.
Stocks slipped back -0.7% to begin the week with big-cap tech shares continuing to struggle as investors worry that the group could be the focus of possible congressional pressure. These stocks largely led the way out of last year’s pandemic-induced plunge; but they have traded flat in recent months as investors rotated into beaten-down cyclical sectors. That shift continued in a flat session Tuesday with oil prices and interest rates advancing yet again as investors bet on an economic recovery primarily in the second half of the year. Another flat day Wednesday with the S&P 500 up +0.2%. Strength in General Motors (GM) continued as the company embraces the shift to electric vehicles. Intel (INTC) shot higher on a change in CEO. A substantially divergent market Thursday with small-cap stocks rallying +2% while the broad market dipped -0.4%. President-elect Biden rolled out a massive stimulus plan which investors took as support for small business and consumer spending, generally. Investors sold stocks down modestly Friday in a -0.7% slide. An investigation of Exxon (XOM) in the hot energy sector combined with a ‘sell the news’ mentality as bank earnings kicked off to sap enthusiasm. Also, investors have received a couple of weaker economic reports this week with unemployment claims ticking higher and retail sales weaker than expected through the holiday season.
A mixed week in stocks with the S&P 500 (SPY) giving back -1.47% while the Nasdaq 100 (QQQ) was off -2.25%. Bucking the trend, small-cap shares (IWM) rose +1.42%.
Warm wishes and until next week.