Capital Market Comment
March 9, 2021
Frank Mastrapasqua, Ph.D.
Principal, Chairman & Chief Investment Officer
As The World Churns
As the world is transitioning to an economy that is opening up after the government-induced pandemic shutdown (Gepression), and adjusting to massive fiscal and monetary stimulus, investment strategists are scurrying about making changes in an attempt to capture the post-pandemic world. Surging trading volume and daily market volatility have accompanied changing investor sentiment. Program trading, algorithm models, and day traders account for the lion’s share of the daily price swings and knee-jerk reactions. The historical relationships upon which many of these models are based constantly being tested and, in our judgment, have yet to prove their worth. Given the long period of stability in key variables such as interest rates, history offers little causal linkages. Consequently, a sudden shift in the 10-year treasury yield produced a level of volatility and uncertainty that caused a sharp downside reaction in the market, particularly among technology stocks.
As a result, strategists and pundits are suggesting significant sector shifts almost daily. Large-mid-small cap, growth, value, emerging, and developed markets are all areas of changing allocations. Many have expressed the view that the Federal Reserve is wrong, inflation is raising its ugly head, and the monetary authorities have already failed.
Such prognostications and the strategy changes based upon such factors should be taken cautiously. The risk-on, risk-off trade and the daily buy and sell ideas will do little to advance investors’ desires to accumulate wealth and manage their retirements.
It is important to recognize that the policy prescriptions (monetary and fiscal) being currently employed are unprecedented. Therefore, it is difficult to determine their full effect. For example, there are leads and lags, and behavioral changes that will be permanent, and the timeline for developments to manifest themselves is uncertain. In our judgment, it is not about growth or value, but about an economy that is emerging from a pandemic-induced shutdown, spurred by aggressive policy action, with secular trends accelerating and cyclical ones emerging. For investors it is important to recognize that corporate profits have responded handsomely, with those of the S&P 500 likely to be up in Q4 versus a year ago, when prior estimates suggested a decline of 11%. Early indications for Q1 imply strong gains and with the additional stimulus of $1.9 trillion, Q2 and beyond should follow suit.
The monetary framework remains a very powerful force for growth and asset values. The Federal Reserve has employed new guidelines (discussed in earlier commentaries): maximum employment (10 million people still unemployed) and flexible inflation targeting (average 2% over a long period of time). Such goals imply a near zero federal funds rate for an extended period of time, likely well into next year.
Even though the 10-year treasury has moved toward 1.6%, the rate level still implies a negative real rate and even more so at the short end of the yield curve. Also, the Fed is continuing its $120 billion a month bond buying program, which is expected to persist all year. The steep upward sloping yield curve, the tight spread between the high yield (junk) rate and the 10-year treasury, and an S&P 500 yield nearly equal to the 10-year rate should offer comfort to equity investors, particularly as dividends are being reinstated and expanded.
The notion that rising interest rates can have a negative impact on growth stocks, particularly those that are valued as multiples of revenue, has merit. Moreover, rising rates do impact the discount rate for all stocks. However, the powerful profit rebound coming from a strong economic recovery provides a benefit that has the potential to exceed the negative effect of rates.
In our judgment, what becomes problematic for the equity market is a Fed-induced rise in rates, a phenomenon that is not likely for some time. Further, it is important to place the level of interest rates in perspective. The 10-year treasury is near the same level as just before the pandemic. It is half of what it was in 2008 and 2009, and even less than half of what it was in 2007. The 10-year rate is currently below the level that has persisted since the financial meltdown.
Secular themes which carry through multiple cycles remain an important part of our portfolio construction. The pandemic only accelerated these trends: e-commerce, artificial intelligence, cloud computing, cybersecurity, internet-of-things, 5G, new drug discovery, biotechnology innovation, etc. Given the correction in the technology sector, many of these great companies have taken on a value proposition.
In recent months, the cyclical growth component has been expanded in our portfolios, thus increasing our participation in the expanding parts of the economy (e.g. transportation, industrials, and financial institutions). By focusing on the fundamentals along with the policy prescriptions and avoiding “crowd think,” we believe the investor should flourish.
If you have a question or need further information, please contact:
Don Keeney, CFA, CFP, Principal & Portfolio Manager in Nashville at 615-866-0882, or email@example.com
Claude Koontz, CFA, Principal & Portfolio Manager in San Antonio at 210-353-0519, or firstname.lastname@example.org
Mastrapasqua Asset Management, Inc. does business as M Capital Advisors.
104 Woodmont Boulevard, Suite 320
Nashville, TN 37205
200 Concord Plaza, Suite 500
San Antonio, TX 78216
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The information and opinions contained in this report should not be treated as fact or as insight that will produce desired investment results over time. Investment conclusions always bear risk, and that risk may not be reasonable for any particular reader. Obviously the writer, even assuming good intentions, does not know of the reader’s particular financial circumstance and therefore is not able to assess the propriety of whether a named security makes sense as part of a given individual, family, or institutional portfolio. Mastrapasqua Asset Management clients may, from time to time, own some of the companies mentioned. We hold out no duty to give readers of this column advanced notification of when we may change an opinion. To our knowledge, none of the information contained in our column would, when it becomes publicly available, have an influence on the valuation of a particular stock. Investors should receive investment advice based on an assessment of their own particular investment circumstances and not on the basis of recommendations in this report. Past performance is not indicative of future returns.