The stock market continued to move higher during the month of April as all the indexes we follow moving higher for the month. Of note, the large cap indexes – S&P 500 and the Dow Industrials – outperformed the small cap index for the first time in a while. One month doesn’t make a trend, but it is something to keep an eye on. The big winner for the month was the CRB Commodities Index. The US Dollar lost more than 2% of its value this month as bonds were modestly higher.
U.S. & International Stock Index Returns
|Index April 2021 Year-to-Date|
|Dow Industrials 2.36% 10.68%|
|S&P 500 4.30% 11.32%|
|S&P 400 (Midcap) 3.35% 18.14%|
|S&P 600 (Small Cap) 0.47% 20.25%|
|MSCI World 3.61% 9.25%|
|MSCI EAFE 2.09% 5.63%|
|Bloomberg Agg. Bond (2.61%)|
|CRB Commodity Index 19.05%|
|US Dollar Index 1.29%|
All data as of 05/01/2021, Source: Wells Fargo Investment Institute. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
“For every complex problem there is an answer that is clear, simple and wrong.” – H.L. Mencken
Magellan Financial is a financial advisory practice that has roots that date back to the mid-20th century. It is quite the legacy of helping family’s grow their wealth as they raise a family, retire in a manner desired, then pass along a legacy to the next generation. We think we have done a good job for our clients over the years. Over these many years there are lessons that are learned, then passed down to the next generation of advisors.
As it relates to the markets, one thing we have learned is that investing can be simple, yet not easy. Simple in that some basics of investing success are very straightforward – invest consistently over many years, don’t be overly aggressive, etc. Not easy in that we are human. Humans are not always rational … more so when finance is involved.
We all want to buy low and sell high. We all want to be contrarian. It is easier said than done. Somebody was buying at the market lows in March, 2009 and October, 2002 … but more were selling. A lot more.
Today we are in markets that feel very opposite those major market bottoms. Economic growth is making a comeback; If you want a job, you can get a job – companies are hiring; Consumers are flush with cash; Company earnings have been stronger than expected. Those are very basic reasons for a simple, yet complicated question: Why is the stock market continuing to move higher?
Low Yields and the Stock Market
From our perspective, the market has continued its uptrend for all of these reasons and more. One big issue that is not being discussed by the talking heads is the effect of low bond yields. From a valuations perspective stocks can (theoretically) trade at higher multiples then they can at higher interest rates. Which, OK, that’s all fine and dandy. We see the low interest rate environment having a different effect on stocks.
Twenty years ago, the conservative income investor could have a portfolio of 75% bonds and 25% stocks and very easily use the traditionally recommended 4% withdrawal rate to meet their spending needs with a relatively low risk portfolio. In that scenario, almost all or all of the income needed would come from the bond income (depending on what types of bonds were held by the hypothetical client). Fast forward to 2021 and the situation has been turned upside down.
Today we are living in a 1.6% world where the income investor is almost forced into equities to meet the 4% recommended withdrawal rate. This has had a profound effect on the flow of investment assets. As the markets were starting to recover from the Great Recession twelve years ago there was a consistent flow of funds away from the stock market and into the bond markets. Why? We were in a 4% world and it made sense to many investors to exchange equity risk for the yield and relative safety of bonds.
Now more than ever, the income investor has either been “forced” into holding equities as they need to receive a return not available with bond yields to make their situation work.
Could the Stock Market Rally be Hitting an Endpoint?
As the stock market indexes, we follow have grinded higher we have become more cautious with our view on what the short- and intermediate-term look like for the stock market for a number of reasons. First and foremost, company reporting season has produced some very good numbers, yet the market reaction hasn’t been very positive. Many a positive report has been met with a selloff as overzealous expectations by “the market” have not been met. This is not unique to our times.
The Semiconductor Index ($SOX), which is a leading indicator of the stock market, has been flashing a technical analysis negative divergence over the past few weeks (see chart #3). While we won’t get into the nitty gritty of it all, the index is ripe for a correction. In our experience it is extremely hard for the stock market to continue to trend higher when the semis are moving lower.
The fear of inflation and the fear of higher interest rates are real. You can see some typical examples of this fear here, here, and here. Treasury Secretary, and former Chair of the Federal Reserve, Janet Yellen, recently suggested interest rates might have to move higher to keep the economy from overheating. None of this makes the stock market investor happy, let alone enthusiastic.
Big picture it is good that we are in a stiuation where the economy is growing at a rate high enough that there is talk about rasining interest rates to keep the economy from overheating. If this leads to a stock market “correction” it’s not the end of the world. In fact, they happen on a fairly regular basis. Sometimes these corrections happen by the price of stocks going down, others occur when the stock market moves sideways for a period of time.
Is There a Tax Rate Hike Coming?
One issue we have discussed with clients is the possibility of a tax rate increase for 2022 on both corporations and high-income earners. These discussions are based on the proposed American Jobs Plan and the American Families Plan that the Biden Administration recently introduced. The tax component of the plans, as proposed, would increase the corporate tax rate to 28% from the current 21%, and would restore the top personal tax rate to 39.6% for the highest 1% of earners. In addition, the capital gains rate for households earning more than $1 million would see the capital gains rate increase from 20% to 39.6%, putting the capital gains tax in line with earned income.
On the surface any tax increase would seem bad for the stock market. History, however, tells us that this clear, simple answer is wrong. BMO Capital Markets equity strategist Brian Belski took a look at the past rate hikes and found some surprising results.
“During the five prior corporate tax rate increases in 1950, 1951, 1952, 1968, and 1993, the S&P 500 index posted an average calendar year gain of 12.9% with positive price returns in each instance. This gain was well above the 4.6% average return registered during the nine annual periods when the tax rate was reduced and also higher than 9% price return for all calendar years going back to 1945.” (source)
That doesn’t sound all that bad to us.
We do see a tax hike in the future as the Biden Administration appears intent on getting both pieces of proposed legislation passed. What we don’t know at this time is what the end product will be. At the beginning of May we are really at the very start of the negotiations with Congress. Until we have a final bill it is pure speculation as to what changes will be made to the tax structure. Assuming legislation gets passed this year, it will then take time to see how the markets react.
The first four months of 2021 have been very kind to those invested in the stock market. We enter the month of May with a number of factors that suggest that a pause in the positive returns may be in order. This could take the form of a “correction” down for the major market indexes or it could take the form of a sideways consolidate of the averages. Those same factors, however, do not change our positive outlook for the long-term.
In the short-term we are cautious but remain bullish for the long term.
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All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
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