The theme of our Q2 Perspectives report published last week was “keep it simple.” That message was underscored this week by an ugly first-half report by a hedge fund caught up on the wrong side of the meme stock frenzy. Given high valuations and frothy risk appetites, 2021 is likely to be full of cautionary tales. Avoiding these pitfalls is not hard.
Melvin Capital, a prominent hedge fund, started the year with $12.5 billion and a big negative bet on Gamestop. Then came the retail squeeze, and overnight the fund found itself down over 50%. This week Bloomberg reported the fund ended the first half of the year with a 46% loss. What is perhaps more amazing is that assets of the fund as of June 1st were $11 billion, indicating that, despite horrible results, they were able to pull in additional assets. There is a certain allure of hedge funds and other alternative assets which create a velvet rope mystique. They have achieved this despite the fact they charge high fees, are generally not very liquid and have tended as an asset class to underperform the stock market.
“Given high valuations and frothy risk appetites, 2021 is likely to be full of cautionary tales. Avoiding these pitfalls is not hard.”Doug Walters, CFA – CHIEF INVESTMENT OFFICER
On the other side of the Melvin story are the retail investors driving up the shares of meme stocks like Gamestop and AMC Entertainment. Just like cryptocurrencies, these stock valuations are not backed by real fundamentals. Instead, they require a constant flow of new investors and assets, much like a Ponzi scheme. Once that demand dries up and prices start falling, they can fall fast as investors race for the exit. Bitcoin is down nearly 50% over the past few months, while Gamestop and AMC are down about 37% and 26% from recent peaks. The race may be on.
Avoiding these investor pitfalls is not hard. A well-diversified portfolio, invested in liquid securities, and rebalanced regularly is a proven winning strategy. It is not that the well-diversified portfolio cannot go down. It certainly can. But those are normal declines and not the sort of permanent loss of capital that can come from unnecessarily risky assets.
Bonds on the move again
Bond yields fell hard this week. After ending the week at 1.43%, the 10Y Treasury dipped down to 1.29% on Thursday. In the world of bonds, that is a big move.
Headlines This Week
Bonds stole the show this week as yields fell almost as fast at they rose in February. Nothing appears to have changed other than sentiment.
- The 10Y Treasury fell from 1.43% to 1.29% before bouncing on Friday.
- This week’s narrative has focused on peak growth, peak inflation, and peak stimulus as we gradually return to a post-pandemic normal.
- All of this was very predictable given the low base that the economy set a year ago, but that did not seem to matter to bond investors this week.
The Growth and Value Battle
The bond rally has been mirrored by growth stocks, which outperformed much of the week.
- Value had a very strong start to 2021. Financials, Industrials, and other cyclical sectors are benefiting from reopening momentum. As the economy improves, this segment of the market has the most to gain.
- In recent weeks, the “peak growth” narrative has inflicted some damage on Value sentiment, enabling Growth to outperform.
- But Value’s day may not be done. While we may have hit the peak year-on-year growth, given how low the base was a year ago, continued reopening momentum has the potential to keep growth well above average for some time.
The Fed released its closely watched FOMC meeting minutes on Wednesday.
- The notes underscored that the committee is talking about a plan for tapering asset purchases.
- They also made clear that patience is important in the process. So, while the Fed has taken a slightly more hawkish tone over the past month, they will not be quick to act.
- There was a discussion of inflation. While acknowledging that inflationary pressures were higher than expected, they still see them as transitory.
The Week Ahead
Central Banks Reconsidering
The Bank of Canada (BoC), Bank of Japan (BoJ), and the Royal Bank of New Zealand (RBNZ) will all have meetings and interest rate decisions next week.
- A further reduction in quantitative easing is expected from the Bank of Canada, even as virus fears escalate again with the delta variant sending countries back into lockdown.
- The Bank of Japan is expected to keep its monetary policy steady as Japan re-enters stricter lockdowns in anticipation of the Tokyo Olympics later this month.
- The RBNZ will garner attention next week as it publishes its forward guidance amongst rising inflation and growth metrics.
- It is expected that the RBNZ will move forward with its forecast for rate hikes, with the first increase moving to November of this year (previously August 2022).
US Banks Looking to Sustain Results
Earnings season is back and will be kicked off by US banks reporting next week.
- Included next week will be Goldman Sachs Group (GS), JPMorgan (JPM), Citigroup (C), Morgan Stanley (MS), Bank of America (BAC), and Wells Fargo (WFC).
- Financial institutions, including banks, have been in favor of much of the first half of 2021, seeing their stock prices continuing to climb.
- After the big banks performed so well in the first quarter of 2021, a slight decrease (5%) is expected as the segment begins to normalize.
Inflation at Home and Abroad
The US, UK, and the Eurozone will all be publishing inflation data next week.
- June’s annual US consumer price index (CPI) is expected to tick down to 4.9% after May’s high of 5.0% slightly.
- If forecasted correctly, this could bode well for the Fed, which has repeatedly stated that this recent surge in inflation is transitory and will subside.
- UK inflation is out on Wednesday and expected to nudge up to 2.2% year-over-year from 2.1% in May.
- Finally, on Friday, the Eurozone’s CPI data is out and to remain relatively low and stable at 0.9%.
Retail Sales Rollercoaster
US retail sales have been inconsistent this year as we have already seen two negative months and three positive months.
- On Friday, the retails sales number is likely to attract the most attention after an unexpected drop of 1.3% month-over-month in May.
- Analysts are not anticipating a rebound for June, with another decline of 0.6% forecasted.
- If this repeated reduction in retail sales comes to fruition, it will support the case for the Fed to be patient before reducing any asset purchasing programs.
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