In today’s Steady Investor, we take a look at key factors that we believe are currently impacting the market, such as:
Bond Yields are On the Rise: What Does This Means for Investors? – Over the last few years, a common narrative in the bond markets has been that yields are at – or near – all-time lows. Low yields result in low borrowing costs, attractive mortgage rates, and have arguably provided a boost to the equity markets for investors starved for yield. But as you can see in the chart below – which looks at the 10- and 30-year U.S. Treasury yields alongside the 5-year forward expected inflation rate – bond yields are on the rise. February will mark the 7th month of flat-to-negative returns for long-dated Treasuries.1
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So, what’s driving U.S. Treasury bond yields higher? We think a strong economic growth outlook, coupled with the Fed not buying as much as promised, are contributing factors. But in our view, the biggest driver is higher inflation expectations (blue line in the chart). If market participants expect higher inflation down the road, they will want to be compensated more today (in the form of higher yields) for long-dated fixed income products. In this way, higher inflation expectations push the 10- and 30-year U.S. Treasury bond yields higher. Higher bond yields could have several implications investors should keep in mind: among them, pressure on high valuation areas of the stock market, and perhaps a positive outcome for companies that benefit from a steeper yield curve. Namely, banks.
Small Caps are Strongly Outperforming. Can It Last? Small-caps have been posting robust performance relative to their mid- and large-cap counterparts, with the outperformance widening to the biggest margin in over 20 years. Indeed, the Russell 2000 Index (small-caps) has climbed some 15% in 2021 alone, setting over 10 new closing records as the S&P 500 lags behind. Zooming out over the past six months, small-caps are outperforming the S&P 500 by 30%. The question is, can it last? Historically, small-caps have done well on a relative basis early in new economic expansions and bull markets. Anticipating strong growth rebounds benefiting companies with room to grow, investors tend to favor small-caps early in a cycle because of the belief they could post the strongest growth rates (and potentially strongest stock returns). Sustained leadership in small caps shows that investors are ‘risk-on,’ but also that investors may be looking for trades outside of the ‘Big Tech’ category where valuations are stretched.4
Higher Prices, Everywhere – Prices seem to be rising everywhere. The price per barrel of oil has been climbing steadily higher. Copper is up over +50% over the past year. Freight prices are up over +200%; lumber prices have jumped +117% on the heels of a housing boom. The S&P Case-Shiller Home price index is up +9.5%.5 To be fair, many of these prices are jumping sharply off lows, so the triple digit price increases are due to low comparisons. But there is another consideration at play here: the trickling effect of higher inflation. Investors should keep a close eye on inflation, because inflation could be the factor that moves the Fed to tighten monetary policy. Recent Fed minutes indicate no appetite for tightening any time soon. But it’s also important to remember that ‘tightening’ does not only happen when the Fed raises rates – there are plenty of ways the Fed can take their foot off the gas, such as paring back quantitative easing. Each time they do, the equity market is likely to respond with volatility (remember “taper tantrums?”).
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Disclosure