A Spring in the Economy’s Step? - Adviser Investments

A Spring in the Economy’s Step?

March 1, 2021

Please note: This update was prepared on Friday, February 26, 2021, before the market’s close.

Despite encouraging economic and vaccine news, both stock and bond markets were roiled over the past week.

The tech-stock-heavy NASDAQ Composite Index logged its steepest slide since October and the Dow Jones Industrial Average endured its worst session in nearly a month on Thursday, one day after hitting a record, as a sharp jump in bond yields amid inflation concerns spooked traders and sparked a tech sector sell-off.

The week’s tumult notwithstanding, we think further stock gains are ahead. Household income and consumer spending are up and the Federal Reserve remains staunchly committed to continuing its monetary support until employment returns in full. Meanwhile, the hastening rollout of COVID-19 vaccines and the proximity of additional government stimulus is setting the stage for an accelerated economic recovery in the quarters ahead.

On a total return basis, the Dow is up 2.9% for the year through Thursday, while the broader S&P 500 index has gained 2.2%. The MSCI EAFE index, a measure of developed international stock markets, has returned 4.2%. The Bloomberg Barclays U.S. Aggregate Bond index’s yield stood at 1.53%, up from 1.30% last week and 1.12% at the end of 2020. The U.S. bond market has declined 3.0% this year.

Rising Rates Don’t Sink Stocks

Interest rates have been marching higher this year as the path to economic recovery has become clearer. The benchmark 10-year Treasury bond’s yield began the month a little over 1% and closed Thursday around 1.6%. In absolute terms, 1.6% still isn’t much to write home about, but the rise was particularly swift and unexpected.

As bond yields have climbed, a bit of “conventional wisdom” has taken hold on Wall Street; conventional wisdom that we think is wrong. The narrative is that rising interest rates are the reason there has been a rotation in the stock market, with growth stocks (think technology) currently on the outs while value stocks (think banks and energy) take the lead.

But we don’t buy it. Rising interest rates are not necessarily bad for growth stocks (or stocks in general). And the numbers back us up.

Going back to 1990, we sorted every month into one of three buckets—those where bond yields were rising, months when yields were falling, and those where yields remained flat relative to the prior six months. Then we compared the six-month returns of the NASDAQ Composite Index (a loose proxy for growth or momentum stocks) against the Dow (a loose proxy for value stocks, given its industrial holdings).

Over this 30-plus-year period, the NASDAQ tended to outperform the Dow, regardless of whether interest rates were rising, falling or flat. In fact, both the Dow and the NASDAQ delivered their best returns when yields were rising!

Note: Table shows rolling six-month returns and yield direction on 10-year Treasurys from 4/1/1990–1/31/2021 along with the percentage of time yields were rising, flat or falling over that period. Source: Morningstar.

Why? We think it’s pretty simple. Interest rates typically rise when the economy is growing; economic expansion is good for stocks. Yields often fall during recessions and bear markets, as the Fed cuts interest rates to boost the economy and investors seek the safety of bonds. You’ll note that the lowest average returns for both the Dow and the NASDAQ occurred when interest rates were falling, not rising.

The media always needs to “explain” every move in the market and rising interest rates have become the scapegoat for recent stumbles by tech stocks. In our opinion, that doesn’t track.

Tech stocks, and last year’s market winners more broadly, were always going to need a breather. No stock or sector outperforms all the time. With a return to a more “normal” economy drawing closer each day, it’s no surprise to see out-of-favor sectors taking a turn as market leaders.

The Labor Market—Still Holding Us Back

On Monday, the Conference Board released its Leading Economic Index (LEI), which tracks a range of 10 factors (including jobless claims, housing permits, purchasing data, stock prices, interest rates, manufacturing activity and consumer confidence) to divine the direction of the U.S. economy. The LEI grew 0.5% in January—the ninth consecutive monthly gain—with seven of the 10 factors indicating expansion.

One continuing drag on the economy though, is, not surprisingly, unemployment.

Sources: The Conference Board, U.S. Department of Labor.

While the latest data on new claims for unemployment benefits suggests improvements, we’re a bit skeptical when it comes to the numbers. States are gradually reopening restaurants, cinemas and other indoor public spaces. Since that’s the case, why are new claims still at levels well above anything we saw even during the depths of the Financial Crisis? If hiring is picking up, who’s doing the firing? Again, we suspect there’s a lot of noise in the data and that, in fact, the job market may be better than what the numbers portray.

As hiring increases in the spring and summer to meet the freeing of pent-up consumer demand for entertainment and travel, we expect to see the pace of economic growth tick up—catching up to the stock market’s status as a leading indicator.

One-Year Stock Gains: Omen or Anomaly?

The anniversary of the March 23, 2020 market bottom is a month away, and if you’re prone to looking at one-year performance numbers, prepare to be blown away. Assuming no change from Thursday’s close, Vanguard’s 500 Index fund (500 Index) will print a one-year return of 50.5% on March 30 this year. (We use the fund, which attempts to mirror the S&P 500 index, since you can’t invest directly in an index.)

Some investors are going to see those index fund returns (and other funds’ one-year returns) and expect the same going forward. We’re not trying to rain on anyone’s parade, but let’s be realistic: That kind of performance is an anomaly, not a repeatable return.

But there’s another conclusion some investors may draw—that the market can’t possibly go any higher. In this case, they may believe it’s time to get out of stocks, or at a minimum continue to hold cash on the sidelines waiting for a pullback.

That may make sense intuitively, but the historical record tells a different story.

We looked at every 12-month return for 500 Index since its 1976 inception on a monthly basis and compared every period against those that followed particularly bullish one-year returns.

Sources: Vanguard, Adviser Investments.

First, the profits you would’ve earned following gains of 20% to 30% were, on average, no different than any month selected at random.

The sample size is smaller for periods where 500 Index’s one-year returns were 40% or 50%, so we have to be careful about drawing conclusions here. In this case, returns were smaller but still positive following gains of 40% or more. But the real takeaway is that even if the market wasn’t going up after these big jumps, the worst periods following 40% and 50% gains aren’t all that bad.

The bottom line: Big one-year returns aren’t a reason on their own to avoid the stock market. And they’re certainly not a reason to deviate from your long-term investment plan.

Podcast: A Tactical Take on High-Yield

Generating steady income while successfully managing risk is what every bond investor aims for—and we think a tactical investing approach can help get you there. Director of Research Jeff DeMaso and Quantitative Investments Manager Josh Jurbala are back for the second part of our multi-episode look at tactical investments, this time diving deep into the investing philosophy behind our AIQ Tactical High Income strategy.

In this insightful conversation, Jeff and Josh discuss:

  • Why high-yield bonds can be safer than you think
  • The role high-yields can play in a portfolio
  • Why a tactical approach can be especially useful when it comes to high-yield assets
  • … and much more

Tactical investing is a disciplined, rules-based approach that can help eliminate the emotional biases all investors are prone to. It’s not for everyone, but is tactical for you? Click here to listen now!

(You can also tune into part 1, “Making Tactical Practical: An Introduction to Tactical Investing,” by clicking here.)

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Financial Planning Focus

Early Retirement Playbook

The surge in unemployment during the pandemic has led some people to retire sooner than they planned. Whether it’s a personal decision or one that has been imposed on you, here are four ways to make early retirement both fun and feasible:

  1. Get a Handle on Your Expenses. Your biggest concern is likely to be “Will my current savings be enough to meet my needs for the rest of my life?” A key first step is understanding how much you’ll need to spend to support the lifestyle you have in mind for retirement. Our Budget Worksheet can help you get started—it allows you to compare your pre-retirement expenses and income against what you expect to be spending and earning post-retirement.
  2. Plan for Health Care. Medicare eligibility begins at age 65. If you plan to retire before that milestone, it’s important to know how you’ll bridge the gap with health care coverage. COBRA—the Continuing Budget Reconciliation Act—gives you the option to pay to keep your employer’s health plan for up to 18 months after you retire. From there, you can explore the private marketplace for coverage until it’s time to enroll in Medicare.
  3. Evaluate Your Social Security Benefits. When you retire early it’s tempting to file for Social Security benefits at once. However, that might not be your best option financially. We have a host of content on Social Security—including podcasts and a special report—to help you think through the decision.
  4. Rethink Your Employment Options. Retirement doesn’t necessarily mean a full stop to working. Consulting on a part-time basis has become an exciting career phase for many of our clients. With a lifetime of expertise and an inclination to work on your own schedule, you may have a number of options—and we can help you work through them.

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Strategy Activity Update

Please see below for a summary of the trades we executed over the week through Thursday and our current tactical strategy allocations.

Dividend Income

No trades this week. 

AIQ Tactical Global Growth

Sold iShares U.S. Home Construction ETF (ITB). Bought SPDR S&P Transportation ETF (XTN)

AIQ Tactical Defensive Growth

No trades this week.

AIQ Tactical High Income

No trades this week.

AIQ Multi-Asset Income

Sold iShares TIPS Bond ETF (TIP). Bought Vanguard Short-Term Inflation-Protected Securities ETF (VTIP).

Adviser Investments’ Market Takeaways

You can find two new Market Takeaways videos on our website. Research Analyst Liz Laprade talked about the recent Congressional hearing on the GameStop imbroglio, and Vice President Steve Johnson explains why it’s all about the “ROC” (rate of change) this week on Wall Street.

Looking Ahead

Next week, we’ll be looking closely at reads on manufacturing and service sector activity, car sales, construction spending, factory orders, consumer credit and the job market, including the February unemployment rate.

As always, you can visit www.adviserinvestments.com for our timely and ongoing investment commentary. In the meantime, all of us at Adviser Investments wish you a safe, sound and prosperous investment future.


Please note: This update was prepared on Friday, February 26, 2021, before the market’s close.

This material is distributed for informational purposes only. The investment ideas and opinions contained herein should not be viewed as recommendations or personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

Purchases and sales of securities listed above represent all securities bought and sold in each strategy during the period stated. Each strategy’s portfolio generally includes more holdings in addition to the transactions listed above and in some cases the securities listed above may only represent a small portion of the particular strategy’s complete portfolio. Further, the securities listed above are not selected for listing based on their investment performance; thus it should not be assumed that any of the securities listed above were profitable or will be profitable, nor should it be assumed that future recommendations will be profitable. Clients and prospective clients should only make judgements about a strategy’s performance after reviewing the strategy’s composite performance information. There is no assurance that each security listed above will remain in the strategy’s portfolio by the time you have received or read this email. Securities are listed for informational purposes and are not intended as recommendations. Existing investor accounts may not participate in all transactions listed above due to each account’s particular circumstances.

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