Delta Fears, Mixed Signals: Shaken &
Markets seesawed and rates plummeted during July as investors continued to digest the ever present threat of the COVID-19 Delta variant. While robust growth prospects remain intact for the world’s largest economy, we continued to witness caution being priced into the US Treasury market. As commented in our recent missive (GLPWM 3Q21 Newsletter), market participants are showing concern that the Delta variant may have the capacity to negatively affect forward economic activity, despite current levels of vaccination in the developed world. Encouragingly, however, is that the link between infection and hospitalization is proving weak for those who are fully vaccinated. Given that the strain on the medical system is the dominant constraint facing policymakers, a modest rise in hospitalizations implies a potential, durable end to pandemic restrictions and a return to economic normality. This is inextricably linked with certain developed countries, including the UK, moving forward with a full-fledged reopening. Ultimately, the outcomes of variant effects are manifold, uneven, and as such, reveal that the road to economic repair is anything but a straight line.
The “tug and pull” dynamics were sustained through the month of July as real interest-rate levels, which take inflationary effects into account, continue to be the key propellant for asset pricing in the financial markets. Broad equity gauges continued to climb, however, there was a modest intra-month drawdown which was prompted by unease surrounding the increasingly pervasive Delta variant. The S&P 500, which covers roughly 80% of the available market capitalization in the US, increased 2.4% (includes both income and price achievement) despite a mid-month mini-correction of nearly 3%. Again, investors adhered to a “buy the dip” mentality, as year-to-date, peak-to-trough declines have been limited by historical standards. Typically, the second year of a cyclical bull market provides for smaller market gains and bigger drawdowns. According to Ned Davis Research, using the Dow Jones Industrial Average (DJIA), in 38 recorded cyclical bull markets the DJIA has experienced a median drawdown of -11.6% during the second year of market recovery. To date, intra-month drawdowns have been consistent, but relatively minor compared to other cycles.
Even as equity markets sustained their erratic ascent, bond markets continued to send guarded signals which could portend a slowdown in global economic growth. During the month, the prominently followed 10-year US Treasury rate declined 22bps (reminder: 1% is 100bps) to 1.23%. We also highlight the “bull flattening” trend – when long-term rates decline faster than short-term rates – which continued over the course of the month. This was evidenced by a decline in the difference between the 2-year and 10-year Treasury rate, which dipped to just above 1% at month-end, compared to a peak of nearly 1.6% in late March. While technical pressures will inevitably exist due to central bank purchases, the messaging from the bond market suggests a gradual deceleration in the pace of economic growth. The continued decline in long-term rates benefitted most fixed income products. The Bloomberg Barclays US Aggregate, which has yet to fully retrace its year-to date losses, returned 1.1% over the month.
|Key US Index Returns||YTD ’21||July ’21|
|Dow Jones Industrial Average||+15.3%||+1.3%|
|Relevant Fixed Income Yields||YE 2020||July ’21|
|US 10-Year Treasury Note||0.92%||1.23%|
|Investment Grade Corp. (C0A0)||1.8%||1.9%|
|High Yield Corp. (H0A0)||4.2%||3.9%|
Source: Factset as of 08/02/21
Overseas, regulatory moves aimed at the education, property and technology sectors sparked heavy selling in the Chinese markets. The CSI 300 Index, which tracks the biggest mainland China stocks, along with Hong Kong’s Hang Seng Index, declined 7.2% and 9.6%, respectively, over the month. Spillover effects were largely limited to Emerging Market (EM) benchmark returns, with the MSCI EM Index declining 6.7% over the comparable timeframe. We note China’s outsized influence on EM performance, representing nearly 38% of the entire benchmark (as of June, 2021). At this point, contagion into other key EM countries has largely been limited due to the isolated and targeted nature of these actions.
The oft-cited reopening trade, which was initially observed as the chief beneficiary of a resurgent US economy, is clearly being tested while creating periodic bouts of volatility. As the markets oscillate between recovery cheer and viral gloom, we reemphasize the importance of risk management, portfolio diversification and an unwavering focus on valuations as key tenets for navigating an unpredictable environment.
Ash Heatwole, CFA
Portfolio Manager, Associate Director of Wealth Management
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The value of fixed income securities will fluctuate with changes in interest rates, prepayment payment rates, exercise of call provisions, changes in the issuer’s credit ratings, market conditions, and other variables such that they may be worth more or less than original cost if sold prior to maturity. There is also a risk that the issuer will be unable to make principal and/or interest payments. Although treasuries are considered free from credit risk they are subject to other types or risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate, and deflation risk, which may cause the principal to decline and treasury securities to underperform traditional securities. 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. Past performance is not indicative of future results and there is no assurance that any forecasts/targets mentioned in this report will be attained. The indices have been provided for information/comparison purposes only. Individual investors cannot directly invest in an index.
ASHLEY “ASH” HEATWOLE, CFA®
Associate Director of Wealth Management, Portfolio Manager