Economic & Market Commentary
Equity markets rallied sharply in December on the back of another tranche of economic stimulus. The FDA authorized emergency use for Covid-19 vaccines and initial vaccinations helped subdue investor fears despite virus statistics steadily multiplying throughout the globe.
December’s risk rally was broad based and clearly showed signs of a reflation trade. Growth, value, cyclicals and small cap stocks all closed out the year with strong performance.
- Major commodities surged as oil prices rose over 6%.
- Gold prices also rose over 6% as the US dollar weakening persisted and inflation fears were stoked.
- Bitcoin emerged as another inflation hedge and rose almost 50%.
- A post Brexit trade agreement between the United Kingdom and the European Union also aided the global rally, most notably in European stocks.
The US yield curve steepened during the month as longer-dated Treasury yields increased relative to shorter maturities. The 2-year note yield fell two basis points to 0.12%, while the 10-year bond yield rose eight basis points to close at 0.94%.
Despite the fall in treasury prices – corporate debt, municipal bonds, and high yield securities all had positive performance as risk premium spreads continued to contract.
Despite positive headlines, economic data was not as robust as the markets suggested. While housing and building remained strong, non-farm payrolls came in much lower than expectations. Consumer confidence began to wane, and retail sales in both November and October disappointed suggesting a lighter holiday season.
The December minutes of the FOMC meeting showed that all members of the Committee backed the current bond buying program. There was some discussion as to the duration of the bonds they will purchase in 2021. In general, the Fed remains in a “dovish lock” as it must continue to provide liquidity to the marketplace. If inflation fears continue to pick up in 2021, market participants will start to once again closely examine Fed statements.
Year End & New Years Thoughts
During March’s bond market liquidity episode and the stomach-churning sell-off in equity markets, it was difficult to picture markets ending 2020 with such robust total returns. Despite the pandemic driven human health toll, lives lost, economic shutdowns and re-openings, vaccine prospects, and political and fiscal battles - one main factor truly influenced the financial markets: the $14 trillion dollars that was pumped into the system by global central banks. The Federal Reserve took unprecedented steps to bolster liquidity, and have all but promised to keep rates close to zero for years to come.
While 2020 was clearly unique in cause and scope compared with the Financial Crisis of 2008, during both periods the Federal Reserve served as a powerful liquidity provider while keeping short-term rates low for an extended period of time. This served to drive every investor out on the “risk curve”. Zero-interest rates obviously benefit corporate borrowers as well as mortgage rates, but low-interest rates and quantitative easing has broader ramifications on markets and on investor psychology.
This search for yield is evident as we see savers and liquidity-focused investors begin to buy intermediate and core fixed income products. Core fixed income investors have begun to look for lower-quality bonds, and high yield investors are now looking to equity market dividend yields to replace the high profiles high yield bonds used to provide. The play-book is similar to what we saw in 2008 and has certainly been the main catalyst for the buoyant returns in 2020. Risks to the “search for yield” certainly exist for asset allocators. Investors should utilize the bond market for predictable income, liquidity, and as a hedge to equity market volatility. Active management in macro-driven strategies will be increasingly important as credit spreads have been driven lower and equity valuations become stretched as risk free rates remain at historical lows.
A new political party in power, ongoing stimulus, and the unknown timeline of the Covid-19 pandemic could easily alter the trajectory of the reflation trade we are witnessing now. Pent up inflation could potentially be an issue if the pandemic response becomes swifter.
Over the past year, Piton’s strategies performed to their stated goals:
- Cash portfolios provided preservation of principal, safety and liquidity even during the scariest and most volatile trading days of 2020.
- Intermediate taxable and tax-exempt portfolios easily weathered the first part of the year and provided solid fixed income total returns while maintaining a conservative duration posture.
- The managed yield portfolio had its worst and best monthly returns ever in past year, (back to back in March and April) while ending 2020 with strong returns for the second year in a row.
At Piton, we are here to create portfolios and products, and provide our investment advice specifically for you. We can assist in writing investment guidelines, sharing market color and framing portfolios for your clients, prospects and teams. In response to client needs, in addition to customized bond separately managed accounts, our portfolio management team in 2020 expanded its efforts to offer solutions to clients of all sizes through ETFs and we continue to team up with others to deliver complimentary products such as an SMA strategy focused on alternative income, which holds a wide diversification of stocks, ETFs, and funds.
Our goal remains to deliver support and strategies tailored for you as an extension of your investment team. We thank you all for your business and trust in 2020, and we look forward to reconnecting with you in person at some point this year but in the meantime, we are here to discuss our services and strategies that continue to help meet the needs of you and your clients.
Wishing you all a prosperous and healthy New Year.