Momentum Fades as Yields Rise
- Stocks moved higher during the first part of February, but they ended the month on a downward slide. Despite the late-month weakness, new all-time highs were reached for most major U.S. equity indices.
- The broadening of the equity market rally continued in February as small and mid-cap stocks outperformed large-caps and value dominated growth.
- One of the big stories in February was the move higher in the 10-year U.S. Treasury yield. It closed the month at 1.44% after ending the day before (February 25) at 1.54% – the highest closing yield level since February 2020.
- Rising rates put pressure on most pockets of fixed income in February. High-yield bonds gained for the month, but most other bond sectors declined.
- Economic data released in February, primarily covering January, reflected ongoing choppiness to start the new year. While the economy is still expanding, the surge in COVID-19 cases this winter has created challenges.
- The near term still holds uncertainties, but vaccines should begin to roll out more broadly in the months ahead, with a third vaccine (by Johnson & Johnson) approved for emergency use. Another round of fiscal stimulus looks likely after the House passed the $1.9 trillion stimulus plan.
The S&P 500, Dow Jones Industrial Average, NASDAQ Composite and Russell 2000 Indices all recorded new all-time highs in February. As stocks rallied, bonds sold off and yields moved higher. Overall, equities enjoyed broad gains in February, while most areas of the fixed income market fell for the month.
Similar to late January, the CBOE Volatility Index (or VIX Index) spiked higher in late February as well. Although not to the level seen in late January, the VIX Index traded above 30 on the last two days of the month. We believed that volatility would pick up in 2021, particularly as COVID-19 cases accelerated during the winter months and a new administration came to power. We have now seen a couple of late-month spikes in volatility in 2021 materialize. We believe investors should still be prepared for periods of volatility over the next several months.
In January, value and growth did not show a significant difference in results. However, that changed dramatically in February as value resumed its momentum from the latter part of 2020, when it was outperforming growth. Across the market-cap spectrum, value sharply outperformed growth in February, which has resulted in a clear year-to-date advantage as well.
We at Clark Capital continue to use our disciplined approach of seeking out high-quality companies with improving business conditions at what we believe are good prices. We still believe that the value/growth disparity that reached a peak last year will likely continue to shift in 2021 with value improving on a relative basis. That occurred in February, continuing the rotation that started in September, and created a positive backdrop for portfolio managers with a quality focus.
The numbers for February were as follows: the S&P 500 gained 2.76%, the Dow Jones Industrial Average advanced 3.43%, the Russell 3000 rose 3.13%, the NASDAQ Composite increased only 1.01%, and the Russell 2000 Index, a measure of small-cap stocks, was the clear outperformer, advancing 6.23%. Mid-cap and micro-cap stocks also turned in stronger gains than their large-cap peers in February.
We will continue to monitor the trend that began to develop in the latter part of 2020 with small and mid-caps outperforming large-caps (as well as value outperforming growth). Large-caps dominated for most of last year, but small-caps made a surge late in 2020 and that momentum has continued during the first two months of 2021.
Looking closer at style, the headline Russell 1000 Index gained 2.90% in February. In a complete reversal from what we experienced for most of 2020, the performance in February was driven entirely by value stocks. The Russell 1000 Growth Index actually declined by 2 basis points (-0.02%) in February, while the Russell 1000 Value Index gained 6.04%. For the year to date, the returns were -0.76% and 5.07%, respectively.
After coming out of the gates strong in January, emerging markets made only modest gains in February. Broader developed market equities showed better strength in February, but still lagged emerging markets for the first two months of 2021. The MSCI Emerging Markets Index gained 0.76% in February and the MSCI ACWI ex USA Index, a broad measure of international equities, made a stronger advance of 1.98%. For the year to date, those two indices show results of 3.85% and 2.20%, respectively.
The yield on the 10-year U.S. Treasury broke above 1% in January and it continued to move sharply higher in February. After closing January with a yield of 1.11%, February closed at 1.44%. The 10-year U.S. Treasury saw yields in February 2021 that it had not seen since February 2020, prior to the pandemic hitting in full force. The most interest-rate sensitive bonds struggled with this backdrop of rising rates. The ongoing and massive support from the Federal Reserve is generally keeping a lid on interest rates, (particularly on the front end of the yield curve) but we did anticipate some steepening of the yield curve would occur in 2021. That steepening has happened and the moves higher in the 10, 20 and 30-year yields have been rather dramatic so far this year.
Fixed income returns were as follows for February: the Bloomberg Barclays U.S. Aggregate Bond Index fell -1.44%, the Bloomberg Barclays U.S. Credit Index dropped -1.74%, the Bloomberg Barclays U.S. Corporate High Yield Index scraped out a slight gain of 0.37% and the Bloomberg Barclays Municipal Index fell -1.59%. Treasuries were negative across the board in February as rates moved higher. The general Bloomberg Barclays U.S. Treasury Index declined -1.81% and longer dated U.S. Treasury indices, like the 30-year, slumped -6.17%, pushing its year-to-date decline into negative double-digit territory, down -10.33%. We continue to maintain our long-standing position of favoring credit versus pure rate exposure in this interest rate environment.
ECONOMIC DATA AND OUTLOOK
Job market data disappointed at the end of 2020 and it disappointed to begin 2021 as well. Non-farm payrolls increased by a modest 49,000 jobs, when estimates were more than twice that number at 105,000. Prior month data showed a larger drop in payrolls, -227,000 than previously reported at -140,000 in December 2020. The unemployment rate did drop unexpectedly to 6.3% in January from 6.7% in December, but the labor force participation rate dropped modestly in January as well. There is still a lot of ground to make up in the job market and the winter weakness, due in part to the pandemic, has slowed that progress.
The widely followed ISM Manufacturing Index was below expectations in January (58.7 versus a 60.0 estimate) and this was a decline from December’s revised mark of 60.5. The ISM Non-Manufacturing Index, which covers the much larger service industries in the U.S. economy, came in at 58.7. This was ahead of estimates at 56.7 and showed an increase from December’s level of 57.7. Manufacturing and service industries have clearly improved from the shutdown period and continue to show solid growth as the economy recovers. Recall that ISM readings above 50 indicate expansion and below 50 signal contraction.
Retail sales (ex. auto and gas) surged in January by 6.1%, easily surpassing the estimate of a 0.8% increase. In large part, this huge increase in retail spending was aided by the fiscal stimulus plan that passed at the very end of 2020, which included stimulus checks to many Americans at the start of 2021. Highlighting the aid received by many Americans, personal income increased by 10.0% in January after increasing by 0.6% in December. Retail spending slowed as we moved into the winter months as the pandemic surged, but the stimulus checks clearly provided a boost to spending activity in January.
The housing market continued to show strength at the beginning of the year, but the recent rise in interest rates and higher commodity prices for items like lumber will need to be watched to see how they impact housing moving forward. Home prices also increased by over 10% on a year-over-year basis in December and affordability and supply will need to be monitored as well. In January, building permits, new home sales and existing home sales all surpassed estimates and all improved from December. Only housing starts were below expectations in January and below the level in December. Housing measures in recent months have been at levels that have not been seen since prior to the 2008 Financial Crisis.
The Conference Board’s Leading Index gained 0.5% in January, just above estimates of 0.4%. The second reading of fourth quarter GDP came in at 4.1%, which was below expectations of 4.2%, but a slight improvement from the prior estimate of 4.0%. As of March 1, the GDPNow estimate from the Atlanta Fed is indicating that first quarter 2021 GDP will rise to 10.0%, so growth is clearly expected to pick up as we start the new year.
The Fed has been unwavering in its commitment to support the proper functioning of the financial system. It will be important to monitor how Fed officials talk about or react to the recent move higher in interest rates. Additionally, after a 5th fiscal stimulus plan was finally passed in the final week of 2020, the House passed another round of stimulus in late February totaling $1.9 trillion. Although there might be some changes to the final plan once it goes through the Senate, it appears this will be a large 6th stimulus plan that will be deployed into the U.S. economy. We will watch closely to see what this next round of stimulus ultimately looks like.
Stocks rallied in February, but bonds struggled as interest rates moved higher. We remain resolute in our belief that the U.S. economy and corporate America will continue to recover as we progress through this pandemic period and vaccines become more widely available. The next few months might see elevated capital market volatility as we go through this challenging period. Overall, we do believe that the economy and financial markets are heading in the right direction. As always, we continue to believe it is imperative for investors to stay focused on their long-term goals and not let short-term swings in the market derail them from their longer-term objectives.
Clark Capital’s Top-Down, Quantitative Strategies
Yields have risen on the heels of an improving economy, continued economic reopening, and fears of rising inflation. According to the current reading of the Atlanta Fed’s GDPNow Forecast, the economy is expected to grow about 10% in the current quarter. That is much higher than consensus expectations, and therefore a contributor to rising Treasury yields.
Our tactical equity portfolios have captured gains by being overweight in small-cap stocks, Financials, metals and mining, and economic recovery themes. Credit has remained very firm, withstanding the backup in yields. As such, the credit risk management models that drive our top-down strategies remain in a risk-on position.
Clark Capital’s Bottom-Up, Fundamental Strategies
February was a good month for risk assets, which generally advanced given the continued improvement in COVID cases and hospitalizations, along with economic reopening themes. The market gave back a little of its outsized gains as the month ended, as rising yields elevated valuation concerns.
The U.S. 10-Year Treasury yield has risen from 0.91% to start the year to 1.41% at February month end. Meanwhile, short-term rates remain fairly well-anchored, resulting in a steepening yield curve. Those trends have favored cyclical themes in the portfolios including Energy, metals, and Financials. In addition, small-cap stocks are outperforming large-caps, and value is outperforming growth stocks. In fixed income, credit is outperforming duration exposure.
|ISM Services Index||Jan||56.7||58.7||57.2||57.7|
|Change in Nonfarm Payrolls||Jan||105k||49k||-140k||-227k|
|Average Hourly Earnings YoY||Jan||5.00%||5.40%||5.10%||5.40%|
|JOLTS Job Openings||Dec||6400k||6646k||6527k||6572k|
|PPI Final Demand MoM||Jan||0.40%||1.30%||0.30%||—|
|PPI Final Demand YoY||Jan||0.90%||1.70%||0.80%||—|
|PPI Ex Food and Energy MoM||Jan||0.20%||1.20%||0.10%||—|
|PPI Ex Food and Energy YoY||Jan||1.10%||2.00%||1.20%||—|
|CPI Ex Food and Energy MoM||Jan||0.20%||0.00%||0.10%||0.00%|
|CPI Ex Food and Energy YoY||Jan||1.50%||1.40%||1.60%||—|
|Retail Sales Ex Auto and Gas||Jan||0.80%||6.10%||-2.10%||-2.50%|
|Industrial Production MoM||Jan||0.40%||0.90%||1.60%||1.30%|
|New Home Sales||Jan||856k||923k||842k||885k|
|Existing Home Sales||Jan||6.60m||6.69m||6.76m||6.65m|
|Durable Goods Orders||Jan P||1.10%||3.40%||0.50%||1.20%|
|GDP Annualized QoQ||4Q S||4.20%||4.00%||33.40%||—|
|U. of Mich. Sentiment||Feb P||80.9||76.2||79||—|
|S&P CoreLogic CS 20-City YoY NSA||Dec||9.90%||10.10%||9.08%||9.20%|
Past performance is not indicative of future results. The views expressed are those of the author(s) and do not necessarily reflect the views of Clark Capital Management Group. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Nothing herein should be construed as a solicitation, recommendation or an offer to buy, sell or hold any securities, other investments or to adopt any investment strategy or strategies.
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