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Strategic Insights

Volume 10, Edition 8 | March 1 - March 5, 2021

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Enjoy the Rollercoaster

Doug_Walters Doug Walters | Articles

Read Time: 3:30 min

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The volatility of the stock market is like a classic rollercoaster. Just as one can get significant joy from the ups and downs of a great coaster, the long-term benefits of stock returns are a function of their wild gyrations.

Contributed by Doug Walters , Max Berkovich , , Frederick Hole

This week, investors were reminded that stocks can go down as well as up. Volatility was significant! While it never feels good to watch segments of your portfolio fall, that is all part of a normally functioning market. Stocks are volatile, and without that volatility, there would be no reason to hold them.

Over the past few weeks, rising bond yields have caused stocks to fall. From the February 12th peak through this past Thursday, the Russell 1000 was down close to 5% (though we got a nice 2% bounce on Friday). Whenever stocks fall, it always creates a bit of investor angst. But this volatility should be embraced.

Have you ever wondered why stocks tend to have higher returns than bonds over time? At the most basic level, it comes down to risk, including volatility. The long-term reward for holding a risky asset like stocks is a higher long-term return. Likewise, short-dated U.S. treasury bonds are nearly riskless, but they offer a much lower return to investors. I liken it to a rollercoaster versus a train. If you are like me, you will get a lot of joy (high return) from a world-class coaster with many big ups and downs. My personal favorite is The Beast at a Kings Island, a classic wooden monstrosity. On the other hand, trains are very stable. They provide a valuable service but do not provide the same thrill (lower return).

As individual investors, we all need some volatility and some stability in our portfolios. More rollercoasters may be appropriate at some points in your life, while at others, trains could be required. We are always here to help you figure out what level of thrill you should have in your portfolio.

Headlines This Week

Non-Committal  

  • U.S. Fed Chairman Jerome Powell said that higher interest rates could become a problem but did not give any specific level of interest rates that the Fed would see as an issue. 
  • The Fed sees the possibility of inflation rising above the 2% target, and if it happens, they predict it will be shortlived.  
  • The big picture is to return the economy to full employment, and it is doubtful that it will be accomplished by the end of 2021. It took the U.S. almost 10-years after 2008 to return the country to full employment. 

 Hospitable Jobs Report 

  • The U.S. economy added 379,000 jobs in February. 160,000 jobs were also added to the January report.
  • The major contributor to the job growth came from the hospitality and leisure (355,000) sector, one of the industries that suffered the most during the pandemic. Government employment was the biggest detractor, with a decline of 86,000 jobs.
  • The unemployment rate fell to 6.2% in February, down from 6.3% in January.
6.2%

The Current U.S. Unemployment Rate

Source: Bureau of Labor Statistics

 Checking in on DC 

  • The $1.9T relief bill is in the Senate’s hands as lawmakers deliberate the bill over the weekend.  
  • Democrats are keen to ratify the bill and deliver it to the President’s desk for his signature before March 14th. 
  • Over the weekend, the Senate will discuss income cutoffs and unemployment amounts, which Democrats raised to $400/week from the current $300/week. 

 Fueling the rise  

  • The Organization of the Petroleum Exporting Countries, also known as OPEC, surprised the commodity markets by extending voluntary production cuts.  
  • Saudi Arabia has been singlehandedly cutting production while other OPEC members promised not to raise output. 
  • The U.S. petroleum inventory remains elevated; Inventory is currently at the level it was at the end of 2015 but has been on a steady drawdown since August. The production cuts by OPEC and the decline in fracking rigs that dampened the production in the U.S. will soon translate to higher prices at the pump.  

The Week Ahead

Pressure on Europe

The European Central Bank (ECB) will meet next Thursday with all eyes watching to gauge the Bank’s reaction to the sharp increase in bond yields. 

  • From Europe’s perspective, the spike in yields is an American story that spills over, causing rates to rise in Europe.
  • Europe’s recovery effort is currently much slower than America’s, with lower vaccination rates and tighter restrictions across the region.  
  • Several senior ECB officials have warned that this spike in yields is unwarranted, with the central bank prepared to fight it.  
  • The question next week is whether the situation is desperate enough to act now or continue monitoring the situation. 

The Ongoing Worry

The story of where inflation is heading continues to be a primary focus for U.S. markets. 

  • The Consumer Price Index (CPI) rate for February will be released next Wednesday and is expected to hold steady at 1.4%. 
  • Any unexpected change in this key inflation metric could ring alarm bells within markets. 
  • The Fed has taken the opposite stance of the ECB, stating that rising yields and inflation are moving higher for “health reasons,” signaling the Bank’s reluctance to intervene.  
  • Additional metrics to watch out for next week will be the Producer Price Index which continues to rise, and the Michigan Consumer Sentiment Index.  

Auction Anxiety

The U.S. Treasury will be holding its monthlauction of 3-year notes, 10-year notes, and 30-year bonds next week. 

  • Anxiety has been building over Treasury auctions after the rough 7-year auction last month showed little demand from investors.  
  • If the trend continues, we could see yields continue to spike as demand dries up. 
  • Timing of auction anxiety is unfortunate with a $1.9 Trillion stimulus package and another large infrastructure bill still to come expected to be funded with debt.  

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