February has been an historically weak month for stock market returns. In 2021, however, the markets bucked the trend. Most everyone we know would be happy with the solid returns from the two US large cap indexes (Dow Industrials, S&P 500) and the international indices we track. The bonus was the continuation of strong returns from both small cap and mid-cap indices. Bond yields continued to rise causing the aggregate bond index to continue its early year slide. Commodities and the US Dollar had positive February returns.
|
U.S. & International Stock Index Returns |
| Total Returns |
| Index February 2021 Year-to-Date |
| Dow Industrials 3.10% 1.06% |
| S&P 500 2.58% 1.47% |
| S&P 400 (Midcap) 6.77% 8.22% |
| S&P 600 (Small Cap) 8.03% 14.27% |
| MSCI World 2.42% 1.37% |
| MSCI EAFE 2.08% 0.99% |
| Bloomberg Agg. Bond (2.15%) |
| CRB Commodity Index 13.49% |
| US Dollar Index 1.25% |
All data as of 03/01/2021, 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.]
One thing that we can say for certain about the markets is that whatever your expectations are for the next twelve months there will be something that doesn’t go as you expected. This is why at Magellan Financial we spend zero time trying to predict where the S&P 500 will be on December 31st. Instead, we prefer to think in probabilities, focusing on data and risk. For 2021 our thesis expects positive equity market returns, a weakening US Dollar, and market volatility. Small company stocks and international stocks should outperform. A lot can go wrong, but a lot can go right.
Of course, we want to make sure that things go right for our wealth management clients. That can only happen if we continue to follow the facts and manage risks. Which leads us to today’s two topics – the case for a stock market correction and the need for a balanced, asset allocated investment portfolio.
A Stock Market Correction on the Horizon?
As we enter the month of March, we are starting to see a setup for a possible stock market correction. The S&P 500 is currently setting up in a classic technical formation that typically resolves to the downside. This is not a bad thing. The stock market does, periodically, correct. And a move to the 3550 area would only represent a correction of just over 10%.
Looking at what is happening in other areas of the financial world reinforce our short-term concerns. Bond yields have been trending higher in 2021, accelerating over the last few weeks. Keeping in mind that the 10-year Treasury enters March with a yield that is slightly higher than it was a year ago (just before we all headed home due to COVID), the stock market tends to get short-term spooked when rates rise too fast.
Bigger picture, the stock market tends to perform well when rates rise. Why? Well, just like rates cratered when the economy essentially shut down a year ago, interest rates usually increase when the economy is doing well. Ironically, when the market gets concerned in the short-term because rates are rising, the truth of the matter usually is the economic background is positive for stocks!!! The result is usually some short-term pain but longer-term gain!!!
Much the same can be said for the commodity index – when the price of commodities are falling it usually isn’t good for the economy or the stock market, and when it is rising it is foretelling of better economic times. Higher commodity prices, however, can eventually lead to inflation.
But here’s the thing about inflation: it is a good thing until it isn’t. In reality, we believe the PERCEPTION of inflation has been a greater threat to the markets than actual inflation.
Which leads us back to our thoughts on a possible market correction in the near term. From a technical perspective the stock market appears to be ripe for a pause. The rising wedge pattern we mentioned earlier has an approximately 80% chance of resolving lower. That would make it probable but not inevitable.
When we consider in the current market environment – rising interest rates, higher commodity prices, and a growing fear of higher inflation – the technical pattern appears more likely to resolve to the downside. As a result, the short-term risks are, in our opinion, to the downside, with a selloff giving reason to add to positions, not head for the hills.
We have a situation where there is a lot of money on the sidelines ($4 Trillion) that can be invested while an air of uncertainty continues to surround the future. In 2008 the initiation of the TARP program by The Federal Reserve Bank led to cash coming off the sideline back into markets. Back then, the bulk of new investments went to the bond market, not the stock market. Move ahead to 2021 and the catalyst is vaccine distribution and heard immunity. We believe that there will be a point where the all-clear signal will be proclaimed and the cash on the sidelines will start to flow back to the markets. Given the current low interest rate environment, we see the new flows heading to the stock market, not the bond markets.
To be clear, we remain positive on both the economic recovery and the stock market moving forward.
The Case for Asset Allocation
With talk of what could happen in the more immediate future out of the way, we want to touch on what the investor should be concerned about over the intermediate to long-term: asset allocation. The immediate, and our biggest concern, is that asset allocation has taken a bit of a backseat for many investors these past few years. This happens when there are a small handful of investments that have done extraordinarily well for a period of time. Think about the small handful of technology stocks that have exploded in price the past few years, or the Exchange Traded Funds (ETFs) that are uber popular today that invest in things like robotics. Or cryptocurrencies. In times like these many investors begin to believe that investing is as “easy” as buy this and get rich.
With more than 120 years of combined market experience, we have read this book before and know how it ends. See, we are old enough to remember what the late 1990s felt like, and what happened when that technology boom came to an end. For those not old enough to remember, or those who are but want to forget that experience, the “hot dots” of the late 1990s cooled off – hard. Many of the mutual fund families and funds that bragged about doubling client monies every year imploded. The tech company retirees who had their entire 401k in company stock because it “never went down” were either forced to change lifestyles or went looking another job to make up for their losses. It was ugly. What we are seeing (and feeling) right now is very similar to the late 1990s into the new century.
But here’s the thing. There were some investors who did just fine after the market peak in March 2000. That investor held a diversified portfolio of asset classes. They owned both stocks and bonds, with wide diversification within both those major asset classes. They didn’t do as well as those who owned what was hot during good times, but they didn’t suffer the same losses of their compatriots after the market peak.
See, the stock market isn’t as rational as you may have heard. In fact, it can be completely irrational. Sometimes individual stocks or sectors get to what can only be described as irrational valuations. Not surprisingly, investors chase returns. In a way we are built to do just that. In our experience, it is the rare investor who can buy low and sell high. No, the typical investor wants to buy high, then sell higher. It works for a while … right until it comes time to sell – not an easy thing to do when you have been correct. Again, its human nature to want to believe the music will continue to play forever.
As we have been saying for months now we believe that there has been a change in the markets that require us to reevaluate what we are invested in. The best time to review your asset allocation is now. Today.
Final Thoughts
The two most important decisions you make when building wealth is how much you invest on a regular basis, and how you allocate your portfolio. It is easy to stray from what we know works over time when there are pockets of the financial markets that are producing outsized, seemingly impossible returns. Selloffs – those both small and large – will also lead investors to unwise decisions. If you have neglected your asset allocation, for whatever reason, now is a great time to review where you are at and reevaluate where you should be moving forward.
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On behalf of Magellan Financial we would like to thank you for taking the time out of your busy day to take in our thoughts and opinions. If you found this helpful, please forward it on to others. If you have any questions on the materials presented, would like to be added to our email list, or would like our help with your investments, we can be contacted at 610-437-5650 or via email.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
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.
Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC, a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company. Magellan Financial, Inc. is a separate entity from WFAFN.
Jonathan D. Soden, Managing Partner Jon.Soden@wfafinet.com
Jeffrey T. Bogert, Partner
Robert I Cahill, Partner Rob.Cahill@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Associate Financial Advisor Jay.Knight@wfafinet.com