Meet the new year
It certainly wasn’t a quiet, gentle start to 2021. Early in January the Democrats won the two close Senate run-offs in Georgia. This secured a Democrat clean sweep of the House of Representatives, the Senate and the Presidency and provided an early boost on the prospect of a sooner, and more sizeable, stimulus package for the US. It also reinforced some of the market themes playing out at the back end of 2020, namely, a rise in longer dated bond yields, a weakening US Dollar and a rotation towards previously unloved parts of the market such as cyclicals, smaller companies and value plays. Despite an assault on Capitol Hill and Trump’s ongoing refusal to concede the election, Biden was inaugurated as intended and immediately set about unwinding many of Trump’s policies, and capital markets paused for breath.
As January unfolded, bond yields and equity markets have been grappling with competing forces. On one hand, policy support remains strong with both fiscal and monetary stimulus. In addition, the vaccine roll-out has offered light at the end of the tunnel and corporate earnings on the whole have remained relatively robust. On the other hand, concerns are being raised around harsher and more widespread lockdowns, future tax hikes, inflation and a tapering of monetary support. This has supported bond yields and restrained equity markets. With market sentiment generally positive, equity valuations are now beginning to be questioned and talk of bubbles is beginning to crop up more regularly. This is fuelled by the policy-driven market liquidity. We’ve perhaps seen evidence of this in the dramatic price surges of Bitcoin and disruptive ‘Tech’ stocks such as Tesla. But towards the end of the month, it appeared in a different way. US retail investors, using social media to act together, and largely using leverage through options to implement their strategies, targeted heavily shorted stocks pushing the price up. This had the knock-on effect of hedge funds cutting risk by reducing both short and long exposures more widely and led the last week of January to be the worst week for US markets since October.
The upshot of these various events saw equity markets down marginally in general for the month. Helped by solid China growth, Asian and emerging markets were the strongest performers, although US smaller companies held on to some of their early strength. Europe struggled, perhaps due in part to its more hesitant vaccine programme. With bond yields rising, sovereign bonds posted negative returns, with credit faring better.
Whilst concerns with valuations and bubbles are at the forefront of our thinking, for the time being at least we still see the policy support and positive recovery sentiment as a powerful driver of liquidity. This will continue to support markets. Whilst risks of tapering central bank support or tax hikes are real, we suspect they don’t play out anytime soon, and in the meantime, loose financial conditions support higher valuations. Whilst liquidity has certainly contributed to some extreme market moves in some areas, it’s not yet widespread. Likewise, evidence of leverage and imbalances also appears confined to specific pockets of markets for now.
The value of an investment, and any income from it, can fall or rise. Investors may not get back the full amount they invest. Past performance is not a reliable indicator of future results. Personal opinions may change and should not be seen as advice or a recommendation.