February Market Performance in a Nutshell
In February, the broad equity indices reported mixed results for the month with the Dow Jones Industrial Average (ticker: DIA) leading the way +2.66% in the US. The MSCI Emerging Markets (ticker: EEM) finished -1.86% and the MSCI ACWI ex-US Index (ticker: ACWX) was +0.24%. The S&P 500 finished closed the month up +1.10% and the Nasdaq 100 (ticker: QQQ) sank -2.57%.
Under the Hood
The top three performing US sectors for February were:
XLE (energy): +21.59%
XLF (financials): +10.16%
XLI (industrials): +5.79%
The three US sectors that lagged the most in February were:
XLU (utilities): -6.55%
XLY (cosnsumer discretionary): -3.05%
XLV (healthcare): -2.48%
Notable investment style performances in February:
IWF (large cap growth): -2.10%
MTUM (momentum): -2.98%
IWM (small cap): +3.66%
IWD (large cap value): +4.89%
Return to normal trade picks up steam in February
A quick look up and down the returns above clearly depicts the story of February. Economically sensitive sectors, small caps, and value stocks stole the show. The performance is reflective of higher expectations for post-pandemic normalization. Growth expectations resulted in rising bond yields as inflation quickly became a hot topic as the 10-year Treasury yield breached 1.5%, and hit a high of 1.614%. The current dividend yield of the S&P 500 is about 1.43%, which means stocks may finally have some competition from bonds. The 10-year rate is considered the risk-free rate, so this move means equities have lost their yield premium over Treasuries for the time being. This chart puts it into perspective. As the yield pressed higher, the stock market exhibited significant volatility, and as the rates hit resistance and backed down, we saw the market melt back up. This was aided by Jerome Powell's testimony that he would continue with current policy as said inflation remains soft.
What do we expect going forward?
We do think we may enter a period where the question of inflation and rising yields continues to dominate the financial news cycle. Economic data has been robust. For example, the ISM manufacturing index reached 60.8%, a three-year high. As it continues to be healthy, the market will keep focusing on the impact of reopening the economy fully. There will likely be a continued interest in every word uttered out of Jerome Powell's mouth as the market tries to decode and decipher any hidden meaning that suggests a potential policy change. We would not be surprised to see more volatility from equities as rates attempt to move higher in anticipation of an unleashing of growth as people get back to how life was before the pandemic. However, it's essential to keep in mind that there are still many deflationary pressures in the economy, which we covered in a recent podcast episode. Some of these pressures include technology keeping prices down, aging boomer population, high unemployment, and vast US debt. When it's all said and done, perhaps modestly higher inflation is all that is in the cards.
What have we been hearing from clients?
The question on a lot of investors minds has indeed been inflation. With the volatility we saw at the end of February, it does speak the idea that sustained rising yields and significantly higher inflation could be what upends this market. We have spoken with two camps of investors and clients recently
Camp 1: Waiting for a crash
Some strongly feel that some inevitable crash will occur soon and that we are in a stock bubble. They think that waiting for this to happen to put money to work is the best plan.
We remind them how dangerous this can be. Let's say your portfolio consisted of the S&P 500, and you sold all your stock halfway down during the COVID-19 sell-off at $2,800. As things stabilized, you were fearful of getting back in too soon. As the market kept rising, you told yourself you'd wait for at least a 20% pull-back to get back in. A 20% pull-back from current levels puts you at around 310, about 8% above the level you originally sold. Decisions like these can significantly hurt your performance over the long term. Further, even if we did see this type of sell-off, it would presumably be on some pretty tough developments, and buying amidst the panic will be hard to stomach.
Camp 2: Nothing can stop this market!
The other camp has been lulled into complacency and is happy to stay invested higher on the risk curve. Their attitude is generally, "yeah, the market is ahead of itself, but what is going to undo it?"
To this camp, we remind them that what goes up must come down. At some point, there will be volatility. The question is, are you positioned to tolerate it? If you have been lulled into complacency or found yourself trying to get greedy, it's best to revisit your plan and review your investments with your advisor for a gut check. Ensure that if some lousy case scenarios play out, you won't find yourself in a hole you can't climb out of.
To both camps, we remind them to check in with their financial plan and see if they are on track to hit their goals. As the opinions on TV grow louder on both sides of the coin, an individual investor's best thing to do is ignore it and stick to the plan. The plan will tell you if changes to your portfolio should be considered.
