February 06, 2021
Monthly Market Summary – January 2021
Global equity and commodity markets continued the fourth quarter 2020 rally and marched higher during the first part of January. For example, major U.S. equity indices reached multiple new record highs and in Japan, the Nikkei 225 arose to a multi-decade high. The price of crude oil rose to above $52 per barrel for the first time in nearly a year. The rally in risk assets was driven in large part by hopes for more fiscal stimulus under the Biden administration after democrats won the Georgia Senate run-off elections and for the end to the pandemic as the vaccine rollout continued. Those same expectations drove U.S. Treasury bond yields higher (and prices lower) with the 10-year Treasury bond rising above 1% for the first time since March 2020. The price of gold also fell on lower demand for safe haven assets.
The beginning of corporate earnings season was another source of investor optimism as several large bank, technology, and industrial companies reported better than expected earnings and provided an upbeat outlook. The global manufacturing sector provided more good news. In the U.S., the Institute for Supply Management’s manufacturing index rose for the seventh consecutive month to the highest level since August 2018. Taiwan’s last index report was at the highest level in almost a decade, and the eurozone index hit the highest level since May 2019. In Japan exports increased for the first time in two years and China’s exports rose 18% from a year earlier. Market participants shrugged off a disappointing U.S. retail sales report that showed the third consecutive monthly decline and weaker job market news. The December payroll report was weaker than expected since nonfarm payrolls declined by 140,000 in December for the first monthly decline since April. In addition, initial unemployment claims news was weak with new claims averaging over 900,000 per month in December, the highest since August.
Things changed late in the month when stock prices dropped sharply on high volume pressured by a variety of events. One of the key events was the worsening COVID news. The number of new cases surged around the world especially in Europe due to new virus mutations.
The surge in cases led to new national lockdowns and travel restrictions. Outbreaks even occurred again in China resulting in the lockdown of 22 million people in Hebei Province. The new restrictions along with the slow pace of vaccination distribution increased concerns that economies could fall back into recession. Another key event late in the month was the first signs of reductions in the unusual level of monetary stimulus related to the pandemic. China began to tighten finanical conditions by withdrawing Rmb78 billion of liquidty from its financial system and policy makers in Brazil began discussions questioning the need to maintain the current degree of monetary stimulus. The late month equity market sell-off was also fueled by uneasiness related to rapid and large price swings as the equity market was hit by unusual trading activity in certain stocks fueled by social media driven “short squeezes”.
U.S. equity market index returns varied widely by market capitalization (cap) in January. Small-cap stocks were the performance leaders with mid-single digit positive returns compared to modest negative returns for the mid and large-cap indices. There was a slight performance advantage for value stocks over growth stocks in the small and mid-cap indices, but growth stocks outperformed value in the large-cap index. The energy sector, with a positive return, had the best return in the large, mid, and small-cap indices on expectations for increasing demand as economic activity picks-up. With negative returns, the consumer staples, industrials, and materials sectors had the lowest returns in the large, mid, and small-cap indices respectively.
Non-U.S. equity index returns were mixed for January. The MSCI Emerging Markets index (EM) posted a positive return for the month and outperformed the U.S. market as measured by the S&P 500 index and the MSCI EAFE index of developed international market equities. U.S. dollar based returns from both the EM and EAFE indices were lower than the local currency returns since the dollar advanced modestly during the month. Growth stocks outperformed value stocks in the EM index, but the opposite occurred in the EAFE index. Consumer discretionary, communication services, and real estate were top performing sectors in the EM index. Industrials, energy, and materials were among the top performing sectors in the EAFE index. On a geographical basis, China and Taiwan were top performing emerging markets countries boosted by strong demand for semi-conductors and other export products. The Latin America index was the performance laggard among emerging markets dragged down by the almost -8% return for Brazil. Among developed markets, the Pacific ex Japan region outperformed Europe which has been hurt by the rise in COVID-19 cases along with new business and social restrictions.
U.S. bond market sector returns were mostly negative in January. Treasury bond prices moved lower during most of the month reflecting expectations for additional fiscal stimulus. Long-term bonds had the lowest returns. The corporate high yield bond index posted a small positive return helped by the improving outlook for energy companies as economies around the world gradually recover from the pandemic impacts. The municipal bond index had the highest sector return at 0.6% boosted by strong reinvestment demand.
The Bloomberg Commodity index had a positive return for the month of January. Returns were positive for each of the sub-indices we track except for the precious metals sub-index. The drop in the price of gold as investors favored risk assets drove the decline for the precious metals sub-index since silver had a solid gain. The grains sub-index had the best return of sectors we track due to high demand from China. The energy sub-index had another of the best returns as oil prices rose after Saudi Arabia announced a one million barrel per day cut in oil production and the U.S. reported a surprisingly large drawdown in oil inventories.
Vogel Consulting, LLC (Vogel) Tactical Recommendations
Various factors are likely to be supportive for economic activity, corporate profits, and asset prices in 2021. The COVID-19 vaccine rollout has provided a pathway for a return to more normal business and social activity which is expected to release a surge in pent-up demand particularly on the services side of the economy and be supportive for improvement in labor markets. Many central banks around the world plan to maintain easy monetary policy. Fiscal stimulus will continue in a number of countries as well. However, there are risks to consider. Optimism on vaccine news coupled with significant amounts of liquidity from the stimulus programs have driven valuations for all asset sectors up sharply. Many technical and sentiment indicators are bullish with some at extreme bullish levels. Markets could be vulnerable if the pace of the return to more normal economic and social activity is slower than anticipated or growth in corporate revenues and earnings do not meet expectations. Potential changes in the U.S. to regulations and in tax policy that could increase costs to businesses or result in job losses could be another source of market volatility as news is reported.
We have a neutral view on growth relative to value preferring to have exposure to sectors benefiting from secular growth trends along with some exposure to cyclicality to participate as the economy improves. We favor equites over bonds with yields still at historic lows. Within the equity allocation, we recommend an equal weight position relative to long-term targets to U.S. large-cap, mid-cap, and small-cap stocks, as well as to developed international market equities. We have moved our recommendation for emerging markets equities to an overweight due to expectations for higher economic growth rates than in developed countries and for a boost to returns from a declining U.S. dollar. Within our fixed income recommendation, we continue to favor short to intermediate maturities. We continue to recommend an underweight allocation to hedge funds. We recommend keeping at least a year of cash reserves as we expect bouts of market volatility throughout the year.
The statistical information contained in this commentary has been compiled from publicly available sources and is presented to you for your review and for discussion purposes only. The information contained in this commentary represents the opinion of the author(s) as of its date and is subject to change at any time due to market or economic conditions. These comments do not constitute a recommendation to purchase, sell or hold any security, and should not be construed as investment advice or to predict future performance. Past performance does not guarantee future results.
The statistical information contained in this commentary was derived from sources that Vogel Consulting, LLC believes are reliable, and such information has not been independently verified by Vogel. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of the Russell Investment Group. An index is not managed and is unavailable for direct investment.