Monday, February 1, 2021
US and International Equities
This month provided mixed results for the major market indexes. The Dow Jones and S&P 500 ended the month lower. The Nasdaq Composite continued its run into the New Year, returning over 1%, but the top performer was the Russell 2000 small cap index, returning 5% for the month. Small caps continue their ascent higher from their robust 2020 fourth quarter finish.
Energy Powers Forward
With regard to the S&P 500 sectors, results were fairly mixed, however the major standout was the energy sector, returning over 3% for January. With West Texas Intermediate (WTI) crude above $50 a barrel, improving the economic conditions of many business involved with the energy patch, market participants took notice and bid these equities higher.
International Market Resilience
International equities finished the month mixed. Emerging markets (EM) stocks, measured by the MSCI Emerging Markets (EM) Index, outperformed developed market equities, as indicated by the MSCI EAFE Index by 4 percentage points in January. The emerging markets run continued from its solid December 2020 performance.
Emerging Markets Emerge
Even with the EM’s robust January performance, LPL Research believes these investments have more upside potential.
The forward price-to-earnings ratio (PE) for EM is more than 25% below that of US stocks, which LPL Research considers attractive (source: FactSet).
Solid EM earnings growth over the past year has kept EM valuations low despite matching the S&P 500 performance in 2020 and outperforming by 4 percentage points year to date.
“We expect solid economic growth across Asia to support continued outperformance by emerging market equities in 2021,” according to LPL Financial Equity Strategist Jeffrey Buchbinder. “China was the only major economy in the world that grew in 2020 and US-China tensions may calm some under a Biden administration.”
US vs. Developed Equity Valuations
The US stock valuation premium over developed international equities remains substantial.
Developed international stocks are trading at a more than 20% discount to US stocks on a forward PE basis, compared with a 25-year average discount of 4% (source: FactSet).
Europe’s valuations are more than 30% above long-term (25-year) averages.
Japan’s forward PE ratio remains 15% below its long-term average and at levels LPL Research considers attractive.
January’s Fixed Income Results
The bellwether Bloomberg Barclays US Aggregate Index finished the month lower, while its yield increased. Moreover, the 10-year Treasury traded in lockstep with the US Aggregate. Major US bond sectors finished the month mixed. High yield municipals, as denoted by the Bloomberg Barclays High Yield Municipal Bond index, was a bright spot in January, increasing over 2% for the month.
International bonds, denoted by the FTSE World Government Bond Index, and emerging markets debt, measured by the JP Morgan Emerging Markets Bond Index (EMBI), ended the month lower, while their yields rose.
Bond outlook update
The extra yield that investors demand for investment-grade (IG) corporates over similarly dated Treasuries was at 1%. This is near the tightest level of the last economic cycle—0.91% in February 2018—indicating strengthening economic confidence but increasingly expensive valuations. We still see an incremental advantage in investment grade corporates over Treasuries, but we still continue to emphasize mortgage-backed securities (MBS) for their lower interest-rate sensitivity. For more on credit spreads and our bond outlook, please read the LPL Research blog titled Credit Spreads Limit Bond Performance Outlook.
Commodities were solid performers in January with the exception of gold. Gold lost over 2% while silver returned over 3%. However, copper finished the month in the green gaining almost 2%. Crude oil returned over 7% as its producers were benefactors of this rise. Natural gas enjoyed a solid start to the year amid the volatility that it witnessed during the fourth quarter of 2020.
US Economic Data Recap
Conference Board’s Leading Economic Index (LEI). The Conference Board’s Leading Economic Index (LEI) increased 0.3% month over month in December. This follows a 0.8% increase in October along with 0.7% increase in November. The growth in the December LEI fell to its slowest pace in six months, nevertheless, the December LEI posted the eight straight monthly rise for the index. The Conference Board noted that improvements in the LEI were broad-based among their indicators with the exception of increasing initial claims for unemployment insurance along with a mixed consumer outlook.
Inflation. Inflationary pressure again remained tame in December, with the core Consumer Price Index rising 1.6% year over year, matching November’s yearly increase. December producer prices, measured by the core Producer Price Index, increased just over 1% year over year. This shows that producers are having marginal success increasing prices as the economy tries to recover from the impact of COVID-19. Inflation has risen slowly from low levels, but may still reach the Federal Reserve’s (Fed) inflation target in 2021, at least temporarily.
US Consumer. The Conference Board’s Consumer Confidence Index increased in January from December’s reading. This was the first uptick in consumer confidence after two straight months of pullbacks for the index. Nevertheless, it currently remains well below the pre-COVID-19 report from February 2020. In addition, the Present Situations Index declined whereas the Expectations Index increased, reflecting the near-term impact of the surge in COVID-19 cases, but the improved longer-term prospects from more widespread vaccine distribution.
US Home Sales. Sales of previously owned US homes increased last month, reaching their highest level since 2006 according to the National Association of Realtors, given pandemic-driven demand. Sales were over 20% stronger vs. December 2019. In addition, at the end of December, the inventory of homes for sale just stood at 1.07 million homes, which is down over 20% year-over-year. This is the lowest number of homes in inventory since Realtors started collecting this data since 1982.
US Business. The National Federation of Independent Business (NFIB) Small Business Optimism Index declined sharply in December and now stands below the average reading for the first time since May 2020. In addition, the reading missed many economists forecast. Given the current COVID-19 climate, small business owners are dealing with major uncertainties, especially amid increased restrictions at both the state and local levels.
Federal Reserve Open Market Committee (FOMC). The FOMC, the Federal Reserve’s (Fed) policy arm, kept interest rates at near zero as expected in its first meeting of the New Year. They noted that the pace of economic activity as well as the employment landscape has moderated in the last few months. In addition, the weakness appears in the sectors most adversely influenced by COVID-19.
The Fed continues to purchase at least $120 billion in Treasuries along with mortgage-backed securities monthly, a pace that the FOMC will maintain until economic progress is made. Moreover, the Fed will be closely watching how the vaccination program is advancing with regards to judging the economy’s trajectory.
US Employment. The US unemployment rate still remains high compared to history. COVID-19 continues to play an adverse role on service industry employment in particular. Even though the unemployment rate has declined from a peak of approximately 15%, we are quite far from having an economy at full employment. The distribution of a COVID-19 vaccine should help the employment landscape.
As the Fed has indicated, market participants will be keeping a close eye on the progress with the vaccination program. As is evident from the economic reports, the effects of government restrictions on economic growth will continue to be closely watched by market participants, although the emphasis will remain forward looking. How we manage COVID-19 in the wake of ramped-up vaccine production and distribution could have a major influence on the investment landscape for the rest of 2021 and likely beyond.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results. All market and index data comes from FactSet and MarketWatch.
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This Research material was prepared by LPL Financial LLC.
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