Market Commentary for the week ending February 27th, 2021
- Signs of economic strength may be bad news for stocks and bond yields continue to rise.
- Emerging market plunge including a -8.5% weekly drop for Chinese stocks.
- Commodities and energy stocks were higher and everything else declined.
Stock Dividend Yields versus 10-Year U.S. Treasury Yields
Investor has a wide array of investment options available to them with some seemingly more attractive than others depending on various circumstances and beliefs. For example, one statistic evaluated by many investors when considering stocks is the dividend yield. All other things being equal, a higher dividend yield makes stocks more attractive. Furthermore, the higher the dividend yield is relative to bond yields may help make stocks more attractive than bonds, again, all things being equal.
The accompanying graph shows the dividend yield on the S&P 500 compared to yields on the benchmark 10-Year U.S. Treasury Bond. This week, the far right side of the graph, the yield on the 10-Year Treasury crossed above the dividend yield for the first time since early 2020. As you can see in this graph bond yields plummeted early last year at the start of the pandemic while dividend yields shot higher due to falling stock prices. After the initial pandemic shock, dividend yields have been steadily falling as stock prices rise and bond yields have surged during the last 6 months. These higher bond yields make bonds more attractive while lower dividend yields do the opposite for stocks.
Not only have dividend yields fallen post-pandemic but they have fallen to multi-decade lows to 1.5%. The only time during the last several decades that dividend yields were lower than they are today was in the late ‘90s and early 2000’s after stock prices had risen sharply. There is concern amongst some investors that the combination of the very low dividend yields and rising bond yields may put some downward pressure on stocks prices. Only time will tell.
This Week’s Performance Highlights
Multiple economic reports (see below) showed signs of strength making investor wonder if the Federal Reserve may have to raise interest rates sooner than the Fed is currently suggesting in spite of testimony this week to the contrary. These fears of potentially higher rates drove bond prices further down and yields once again higher making stocks less attractive. This serves as a powerful reminder of the incredible impact of extremely low interest rates on all types of investments.
- At the close of the week, large U.S. stocks were down -2.5% as measured by the S&P 500 leaving them higher year-to-date by just +1.7%. The Dow Industrials fared a bit better for the week off just -1.8% while the tech-heavy NASDAQ was hit relatively hard falling -4.9%.
- Small U.S. stocks, among the strongest group so far in 2021, were off -3.1%. A strengthening economy is considered very good for this group but higher interest rates could be a drag as smaller companies tend to have to pay higher rates than larger companies.
Every sector was lower except energy with higher growth technology stocks, as an example, down -3.9% while more value-oriented stocks such as financials were only down -0.3%. As the accompanying graph shows, growth and value stocks were neck-and-neck through mid-February. During the past 2 week though growth stocks have lost most of their 2021 gains on the fear of higher interest rates.
- International stocks, in particular emerging market stocks, were hit hard plummeting -6.6% on average. Brazil and Turkey stocks were among the biggest losers plunging -10.6% and -10.4% respectively. China, the biggest of the emerging markets, sank -8.5%. Some research shows that when bond yields rise rapidly, it puts downward pressure on emerging markets as these highly leverage economies may incur significantly more interest expense over time.
- Developed international markets were off more like U.S. markets down -2.9% for the week. Eurozone markets held up better than average with stocks in Spain, for example, down just -0.3% while the Japanese market fell -4.4%.
- Commodities were the only asset class higher for the week gaining +1.4% helped by the price of a barrel of oil climbing more than $2. Gold, a bit surprisingly, fell another -3.1% and is now off -9.3% for the year. Often we see gold rise when stocks fall sharply but that was clearly not the case this week. Real estate stocks held up remarkably well off just -0.3% for the week and higher in 2021 by +5.1%
- All attention was on bonds, as already discussed extensively, with prices falling on average by -0.4% as high yield corporate bonds suffered more so that government treasuries. The yields on the benchmark 10-year U.S. Treasury closed at 1.415% up from 1.340% the week before. It had crossed above 1.5% late in the week before pulling back on Friday.
If you ever wondered if you can lose money owning U.S. Government Bonds…the answer is yes. As of Thursday’s close, an index of 25+ Year Zero Coupon U.S. Treasury Bonds was off -27.6% from its 2020 high. Zero coupon longer-term duration bonds such as these are more susceptible to changes in bond yields but all bond prices have suffered to some degree the last 6 months.
While the S&P 500 is off just -2.9% from its all-time high, Apple (AAPL) is down -16%. Although Apple remains the most valuable public company in the world at $2.036 trillion, it has lost $367 billion from its all-time high in late January.
Nearly every economic report came in stronger than economists had expected. This was all certainly good news for the economy but, an economy that gets too strong, may require the Federal Reserve raising interest rates to avoid the risk of inflation.
The durable good orders report, a measure of orders for longer lasting products, jumped +3.4% or more than triple what economists had forecast and a big improvement from the +1.2% rise the prior month. This headline number though was inflated by a huge jump in orders for aircraft which can be very volatile. When removing the transportation sector from the numbers orders grew a more modest +1.4%. Another key measure in the report, business investment, climbed for the 9th consecutive month indicating continued growing optimism about future sales and the health of the broader economy. Today’s durable goods orders, aside from a brief spike in 2014, are now higher than they were pre-pandemic and at record levels as the accompanying graph shows.
The housing market remains hot with new home sales up +4.3% to an annualized rate of 923,000 with the biggest gains in the Midwest while the Northeast saw sales decline. Compared to a year ago sales are higher by +19% but its only been the Midwest and South improving while sales over the past year have fallen in the Northeast and West. Continued relatively low inventories and possibly higher mortgage rates could keep sales from growing substantially in the future.
The S&P CoreLogic Case-Shiller Home Price Index, a measure of prices in 20 cities, showed home prices up +10.1% over the past year making this the biggest annual gain since 2014. Cities with the fastest rising prices include Phoenix, Seattle, and San Diego. A separate report from the Federal Housing Finance Agency showed similar price gains.
Initial jobless claims took a surprising dip coming in at just 730,000 for the week compared to 841,000 the prior week and economists’ estimates of 845,000. This coming week’s monthly employment report is expected to provide a more complete and accurate picture of the employment market.
Stimulus checks, and more likely on their way, helped drive consumer spending higher by +2.4% in the most recently month making it the best month since June of last year. Personal income rose a much larger +10.0% suggesting that the saving rate continues to be much higher than the long-term average (click here to see the 70-year history of savings rates).
Upcoming Economic Reports
- Employment Report
- Initial Jobless Claims
- Factory Orders
- Motor Vehicle Sales
- ISM Manufacturing Index
- ISM Services Index