Market Update: Jan 14 2021
- Treasury Yields
- Senate Election
Here is a recap of our live Q&A session held on 1/14/21 presented by Joe Randazzo JD, CFP® from FNA Wealth Management and Dave Stone CPA, CFP® from Tartan Wealth Management.
Details for our next session, 1/29/21, can be found here. Please note the time and date change to Friday morning at 10:00 AM.
We’re starting to hear predictions of higher inflation and higher Treasury yields. Is this combination typically good or bad for equities? What does this mean to the retail investor?
We’re not surprised to see signs of inflation and projections of it climbing in 2021. Inflation and higher interest rates tend to go hand-in-hand. While the Fed has reiterated their stance of keeping the fed funds rate near 0%, the treasury yields have been on the rise since the announcement of a vaccine. The 10 Year Treasury yield was hovering around 0.65% when the announcement was made and today we find it at about 1.1%. I would not be surprised to see that at about 1.5% by mid year and maybe even higher in the second half of the year as distribution of the vaccine starts to take hold and the economy starts to get going again.
The Fed has targeted inflation at roughly 2% for quite some time and has fallen short by many measures. Now, the expectation is inflation may be closer to 2.5% by the end of the year. So, with higher inflation and higher interest rates, it certainly begs the question how will markets be affected.
First, the bond market. Traditionally bonds are very interest rate sensitive—interest or yield goes up, and price goes down. Dave and I have been talking about actively managed bond funds for quite some time as a way to potentially combat the interest rate sensitivity of traditional bonds. In other words, an ETF or mutual fund that has a manager with the ability to buy and sell bonds in an effort to navigate interest rate movements. Secondly, floating rate bond funds are another way to combat interest rate sensitivity. These could be a little bit tricky, as they tend to have ratings below investment grade, so the default risk within the portfolio is naturally higher. Finally, inflation adjusted bonds could be looked at as part of an allocation. Your traditional bond has interest rate sensitivity, but a bond tied directly to the CPI index or inflation rates, in theory, will be unaffected simply by interest rate movement and should perform positively in a rising inflationary environment.
As for the equity markets, traditionally, growth stocks have underperformed during times of higher inflation. And, so, higher inflation may be another argument for value investing in 2021 rather than growth investing. Consumer staples—or goods and services consumers tend to buy regardless of price increase—have been a go-to in times of higher inflation. Real estate is another area that has traditionally done well as rents rise along with inflation, potentially increasing the profitability and market value of investment property. Commodities also tend to do well during higher inflation times. The higher cost of materials being passed on to the consumer essentially creates the ability to increase profit.
Many had expected Republicans to retain at least one Senate seat in the run-off last week. With that election ending the way it did, does that change your strategy at all for 2021?
To say I’m surprised by the outcome of that election would be an understatement, and I don’t believe I’m alone in that. But, as you’ve heard Dave or I say several times over the last 8 months, it is uncertainty that the market really dislikes. The fact that there isn’t gridlock in Congress as we had expected doesn’t necessarily make it a bad investment environment, it simply means the areas that drive the market may change. With Democrats in control, we believe government spending will increase, which should lead to job creation and will be another catalyst for inflation. We also believe tax reform is back on the table, although we don’t believe it will be addressed in 2021.
In short, coming into 2021, we were expecting value stocks to gain some steam, growth stocks to slow down, interest rates to creep higher and international stocks to do well. None of that has changed as a result of the Georgia election outcome.
The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts or Lincoln Investment. The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.
Although bond funds may pay higher yields than other fixed income investments (sometimes due to the fact that it may contain a high proportion of less-than-investment grade bonds [so called “junk bonds”]), it does not negate the fact that the market value of all bonds fluctuate. Their net asset values are sensitive to interest rate movements (a rise in interest rates can result in a decline in value of the investment) and other factors. Therefore, upon redemption your share value may be worth more or less than your original investment.
A floating interest rate, also known as a variable or adjustable rate, refers to any type of debt instrument, such as a loan, bond, mortgage, or credit,that does not have a fixed rate of interest over the life of the instrument. In evaluating a floating rate fund, investors must ensure that the securities a fund holds are adequate for their risk tolerance. Floating rate funds offer varying levels of risk across the credit quality spectrum with high yield, lower credit quality investments carrying considerably higher risks with greater potential for higher returns.
Growth investments focus on stocks of companies whose earnings/profitability are accelerating in the short term or have grown consistently over the long term. Such investments may provide minimal dividends which could otherwise cushion stock prices in a market decline. Stock value may rise and fall significantly based, in part, on investors' perceptions of the company, rather than on fundamental analysis of the stocks. Value investments focus on stocks of income-producing companies whose price is low relative to one or more valuation factors, such as earnings or book value. Such investments are subject to risks that their intrinsic values may never be realized by the market, or such stock may turn out not to have been undervalued. Investors should carefully consider the additional risks involved in both growth and value investments. International investing involves special risks, including, but not limited to, the possibility of substantial volatility due to currency fluctuation and political uncertainties.