The Week Ahead
There is a smattering of economic data trickling in next week, perhaps the most important of which will be Chinese PMI manufacturing and services (non-manufacturing) data for February on Monday, US services PMI data on Wednesday, and some employment and a slew of other data from the US during the latter half of the week. Fed Chairman Powell is also on a panel at WSJ Jobs Summit on Thursday (12h05 EST / 17h05 GMT) – here’s the link.
Rate pressures eased in the US Treasury market on Friday, but I expect we have reached a new trading range for yields (1 yr UST in 1.40%-1.55% context). The yield curve is continuing to steepen. Whether you want to define this as optimism about economic growth or growing concerns around future inflation is up to you, but I suspect that equities will adapt and move on so long as there are no further unexpected gaps up in yields.
The $1.9 trillion Biden mega-fiscal stimulus plan continues to progress through its approval channels in Congress, with a target to be approved by mid-March. You can learn more about the fiscal plan by reading an article I wrote in my blog a few days ago: “The Next Round of Fiscal Stimulus (US)”.
More earnings are coming this week, including high flyer / new tech names which I will cover early in the week: Zoom Comms, Lemonade, Snowflake and Sea Limited. 479 of the S&P 500 companies have now reported earnings and this is the last really significant week (16 companies reporting).
The likely direction of equity markets this coming week is clear: either investors shake off their concerns and equities head higher, or the concerns linger and the market consolidates or weakens. My bet, given the money flowing from the Fed and an about-to-be-approved $1.9 trillion fiscal stimulus plan, is that last week will be quickly forgotten, as has every rough patch since stocks began recovering post-pandemic.
I will reiterate that as enticing as yields might look at the moment in US Treasuries (at least relative to yields during the post-pandemic period), USTs will remain under pressure so are not the place to be. In credit, investment grade bonds are vulnerable to increases in UST yields, so tread carefully. High yield bonds are slightly less vulnerable because of their wider spreads. In equities, reflation / recovery trades and the go-go high vol names will continue to feature, although many of the new tech names remain so richly valued that their upside might be limited.
What Happened Last Week
Market gyrations were severe this past week in the equity markets, with the culprit clearly being the sudden and severe increase in US Treasury yields. It’s hard to say
exactly what happened so suddenly to cause the yield on the 10-year US Treasury to balloon out, increasing over 20bps on Thursday alone before settling on Friday to close the week yielding 1.44%, well off its intraday wides on Thursday. The graph to the left from the FT illustrates the journey in the 10-year US Treasury yield last week. The table below illustrates yield migration over the last 12 months. As you can see, US Treasury yields are higher across the board in a trend that began in the summer, and they are sharply higher the first two months of this year. The yield curve is also much steeper, signalling economic growth, inflationary concerns or some combination ahead. Lastly, you can also see that the US is not alone, as government bond yields have increased sharply this year in the UK, the Eurozone and Japan, too.
The collateral damage of higher yields drifted into equities, as investors viewed higher interest rates as negative for stocks even though higher yields imply that economic strength lays ahead (Fed Chairman Powell’s narrative in fact). Asian and European equities followed the US equity markets lower late in the week as there was nowhere to hide. European markets were down 2-2.5%, the Japanese equity market (the best performing equity market the last six months) was down 3.5%, but the real pain was in China (down 4.7%) and the emerging markets (down 6.4%).
In the US, the risk-off sentiment was particularly damaging to high flying tech stocks and mid-cap names, as the Russell 2000 and the Nasdaq were the worst performers last week, whilst rather unusually, the DJIA was (relatively speaking) the best performer although there was red across the board. Solid earnings from many companies did not shield them from indiscriminate selling on Wednesday and Thursday as concerns over higher yields dominated the news. Even the reflationary beneficiaries like banks, energy companies and cyclicals got caught in the downdraft.
Even so, corporate earnings were fairly solid with a number of high flying and well-known tech companies reporting earnings in the US. You can find the high flyers I wrote about last week here, and I will provide a post-earnings update before the beginning of next week in the “comments” section of that post. These companies included Nvidia, TelaDoc, ETSY, Square, Airbnb and DoorDash. More generally, the excellent Refinitiv weekly report on S&P 500 earnings – “This Week in Earnings” – can be found here.
The VIX widened from around 22 at the open on Thursday to nearly 31 just before the market closed that day, one of the more severe moves I recall in a single day. The VIX remained elevated as the week ended, closing at 27.95
In credit, there was nowhere to hide as yields moved out in both investment grade and high yield. In high yield, the weakest rating category had the least severe adverse movement (because it has a much wider spread to absorb increases in Treasury yields). European high yield weakened too, although the weakness was not as pronounced as in USD high yield.
The US Dollar (and Yen) behaved as one might expect, with the combination of higher Treasury yields and risk-off sentiment drawing investors to safe haven currencies. However, gold continued to weaken, falling another 2.9% on the week in spite of growing concerns regarding inflation and uncertainty caused by financial market volatility. The WTI oil price increased 4.5% on the week, with oil closing at $61.67/bbl. Bitcoin got hammered, down 16.5% compared to the prior week.
A few other things worth checking out
Janet Yellen was interviewed by New York Times and CNBC reporter Andrew Ross Sorkin on Monday on his DealBook DC Policy Project webcast that you can find here. I thought Ms Yellen was unambiguously clear in articulating her objectives from the perspective of her role as Treasury secretary. She outlined her thoughts regarding the pending $1.9 trln fiscal stimulus plan, obviously pushing for it, with the objective of getting unemployment back to pre-pandemic levels. You can read my thoughts on the Biden stimulus plan in an article I just wrote here. Ms Yellen also commented on her outlook for potential tax increases. She sounded off against a wealth tax although would consider “tweaking” inheritance tax rules, suggests that a corporate tax increase is likely, and that an increase in capital gain taxes is possible.
Fed chairman Powell addressed the Senate Finance Committee on Tuesday and Wednesday, with the major points being that the Fed would continue its current accommodative policies for the foreseeable future, Mr Powell stated that he was not concerned about inflation. On the latter point, he was clear to say that he viewed the uptick in UST yields (at that point orderly) as a reflection of more optimism about the future direction of the US economy rather than inflationary concerns. His conclusion on the current state of the US economy was far from optimistic as he said “However, the economic recovery remains uneven and far from complete, and the path ahead is highly uncertain.” You can find his opening statements on the Federal Reserve website here.
For UK readers, there was a very good article by John Authers in Bloomberg Opinion early last week about the U.K.’s future entitled “The Post-Brexit Bull Case Is Getting Stronger”. As you might surmise from the title, Mr Authers makes a strong case for U.K. equities and Sterling in his article, a scenario with which I agree.
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