Equity market volatility reappeared in the month of February alongside rising interest rates. Adding to the concerns surrounding rising rates and its potential impact on inflation, the price of crude oil surged 10% in the back half of the month to one-year highs after OPEC decided against raising production levels meaningfully. The 10-year yield in the US traded above 1.5%, and rising inflation expectations were evident when the 5-year TIPS breakeven topped 2.5% for the first time since 2008. Speculative growth stocks, in particular small caps, experienced a sharp pullback, while value stocks outperformed, led by the bounce in energy markets. In Australia, the ASX200 gained around 1.5%, notably less than the 2.7% rise in global equity indices. Earnings season was broadly robust, but even this could not offset the worries around rising interest rates late in the month. The 10-year Australian Government Bond yield ended the month of February at 1.88%, up from 0.97% at the start of 2021.
Summary
- US equity markets pushed to new highs early in February, although they finished the month off their best levels due to rising interest rates.
- Crude oil made a 52-week high while Gold traded down to an 8-month low.
- Close to 80% of the companies in the S&P 500 reported an earnings beat with estimates on EPS close to a record level.
- Total global COVID-19 vaccine doses administered reaches 240 million during the month.
US Equity Markets
February provided only modest gains for US equity markets despite pushing to fresh highs early in the month. Fiscal stimulus plans, an improved vaccine rollout and reassurance from the Federal Reserve that interest rates will remain low to support the economic recovery gave investors confidence to put capital to work. Sentiment started to wane late in the month, with the return of volatility and choppy trading as interest rates began to pick up.
US bond yields are primarily driving market direction, with the yield on the US 10-year up over 50 basis points since the start of 2021, trading higher the S&P 500 dividend yield (around 1.53%). All this on the back of an improved economic outlook, higher GDP forecasts and improved consumer spending trends. Stock market performance and bond yields tend to trade inversely. As bond yields rise (prices falling), investors will often rotate into equity markets, yet we have seen some of the strongest performing equities in the last year sell-off with the rise in yields.
Optimism about the economy returning to normal has led some investors and lawmakers to voice concerns about the possibility of a sharp rise in inflation. While many might think this is tomorrow's problem, there is a chance that the $1.9 trillion fiscal stimulus package could potentially lead to an overheated economy. The Fed is doing its best to push back on this train of thought by saying they are not worried about inflation, saying, "The economic recovery remains far from complete, and the path ahead is still highly uncertain."
US Economic Data
With the gradual improvement of economic data in the US, the pandemic's recovery is undoubtedly trending in the right direction. Consumer spending saw the most significant advance in over seven months in February, up 2.4% from the previous month, aided by an uptick in employment and the latest round of stimulus cheques. The US unemployment rate is now at 6.3%, steadily improving since the peak in April 2020 of 14.9%. Still, far from its best levels in early 2020 of around 3.4%. Consumer spending accounts for close to 60% of US GDP, so both of these factors bode well for the economic recovery.
Growth stocks vs Value stocks
Since the beginning of the COVID pandemic, Growth stocks have outperformed Value, yet in February, this was not the case, with Value outperforming by a margin of 6 basis points. Some of the best performing tech names which carry large index weightings are starting to pullback with rising interest rates, leading some to question a possible impact on earnings growth as a result. Positive momentum in the economy should boost Value names in the months ahead as the economy re-opening trade plays takes flight.
Volatility Returns
The market fear gauge measured by the Volatility Index (VIX) briefly spiked above the 31 level during the bond sell-off in the last week of the month. Historically, a rising VIX index does not always mean equity markets will decline, but it is worth noting what asset classes outperform in the event of a market pullback. For context, the VIX index spiked above 80 at the start of March 2020, so we are at modest levels by recent standards.
Copper is in Demand
The price of copper gained close to 15% during the month of February, posting its largest monthly gain in over four years as hopes for a fast recovery led investors to drive prices close to an all-time high. Demand for copper is often seen as a leading economic indicator due to its application in manufacturing and infrastructure projects. Copper futures traded as high as $4.35 per pound in February, close to the previous high set in January 2011 of $4.60 per pound.
Price of Oil
Oil surged during February, with both Brent Crude and WTI trading to one-year highs, both up close to 20% in the month. Prices have now all but recovered the COVID-19 slump as the economic recovery gains momentum. OPEC and Russia decided against unleashing a flood of crude on to the market after Saudi Arabia urged fellow oil producers to "keep our powder dry" in the face of persistent uncertainty linked to the pandemic, which helped lift prices.
Safe-haven Assets
In line with the sell-off in the bond market and other safe-haven assets, Gold declined over 6% in the month of February, which is the precious metals worst performance since late 2016. YTD spot Gold prices are down close to 8.5% as equity markets have provided better returns. Gold futures peaked in early August 2020 at around $2090 per ounce and were last traded in February at $1720 per ounce.
Bitcoin Euphoria Continues
Bitcoin enjoyed another strong month of returns, trading as high as $58,000 during February but consolidating into month-end. So far, in 2021, the cryptocurrency is up close to 60%. The optimism in the digital asset space is mainly on the back of many public companies and investment houses seeking alternative payment methods and investments. Many investors still treat bitcoin as a sideshow. Still, Elon Musk, Burger King, and Mastercard's adoption suggest it is slowly gaining acceptance by some as an alternative asset class.
The Months Ahead
With the positive momentum starting to build in the economy, the path of least resistance seems higher for risk-assets in the medium term. Still, short-term volatility is possible with interest rates backing up. The rotation from stay-at-home names into stocks that will benefit from the economy re-opening is one to watch but keep in mind that any potential spike in new virus cases as businesses begin to open their doors will impact this. Higher interest rates will spur renewed debate on whether the key driver is growing inflation pressures or the improving economic outlook as it relates to what is hopefully a receding pandemic.