A trifecta of good news to kick off the week – from Moderna’s vaccine to the potential of avoiding national lockdowns to the election – means the pieces should be falling into place for strong stock market returns powered by a globally-synchronized recovery from the pandemic. As a global, actively-managed, asset allocation investment firm, those returns would be good news across Horizon Investments’ three stages of the investor journey: Gain, Protect, Spend. For investors in the Gain stage, they should examine their portfolio allocations to see how a global economic rebound would affect the timeline for reaching their goals. It’s clear the stock market’s leadership is shifting to small companies and away from the large-cap names which have dominated since March.
That rotation, which is only in its beginning stages, indicates many investors are more willing to speculate in higher-risk companies. The fundamentals support that shift with Moderna’s preliminary vaccine trial data showing almost 95% efficacy in protecting against Covid-19 infection, echoing Pfizer’s success last week. Meanwhile, the chances of a national lockdown to fight the virus’ spread are falling after medical advisers to Joe Biden said locally-targeted measures will work better than shutting down the nation. Lastly, the presidential election fight is winding down with Biden building an insurmountable lead.
For investors in the growth stages, our Gain and Protect models remain fully invested at their target allocations.
In a year full of superlatives, last week did not disappoint. Pfizer’s positive vaccine data drove equity markets higher, with global stocks (MSCI AWCI) notching a 2.3% rally, building on the prior week’s 7.6% gain. That pales in comparison to the real story of last week: a violent rotation away from tech and large caps into small caps and value. Russell 1000, RTY outperformed large caps by about 4%, while value beat growth by just under 6%. The tech-heavy NASDAQ 100 ended 1.3% lower on the week, and many of the recent winners were sold in favor of the year’s laggards (see last week’s Big Number post for details on the momentum unwind).
Looking at the rotation from another angle, the Russell 2000 Index’s two-week gain of 12.9% is the eighth largest in the 42-year history of data compiled by Bloomberg. Four of the seven larger two-week returns occurred in late 2008 and early 2009 as the bear market caused by the global financial crisis was in its death throes.
It’s unlikely the equity markets will continue to have such a smooth ride higher. Last week’s price action was mainly driven from the short side, with unwinds of positions against Covid-losers, not fresh buying. It will take time for longs to build, given some investors will question when vaccine shipments will be big enough to have an impact. But with the clarity we got last week, that stock market rotation will likely continue. There will be bumps – Covid restrictions are coming, which likely caused some investors to reverse last Monday’s big gains in the following sessions – but the reasons to shelter in mega-cap tech and growth are receding. The good news is that lockdown-lite appears to be working in Europe, with cases plateauing or in some countries falling.
At the index level, the speed of the recent gains – the S&P 500 (SPX) and Russell 2000 (RTY) are up 9.7% and 13.4%, respectively, so far this month – are short-term warning signs of overbought conditions. Systematic investors also appear to be building positions in equities. Retail investors are crashing the party as well. According to the American Association of Individual Investors (AAII), the bull vs. bear spread is at the highest level since the VIX blow up in early 2018.
Regionally, last week’s price action was much less extreme. The vaccine news provided a boost to International Developed Markets, and especially Europe, finishing up 3.9% last week (MSCI EAFE). Emerging Markets lagged, a reflection of its recent defensiveness to Covid due to its concentration in Asia (MXEF EM +1.0%). However, we believe that there are opportunities in Emerging Markets, while Europe will continue to face headwinds due to banks making up a large portion of EU indexes. Domestic shares split the difference last week, returning +2.2% (SPX).
Political uncertainty is fading with President Trump’s acknowledgment of the results over the weekend, although markets never really took his legal challenges seriously. We believe the narrowness of the Democratic majority in the House rules out wholesale legislative changes regardless of the outcome of the results of the Georgia Senate seat runoffs (See our Election Special Report on November 4).
Fixed income markets reacted strongly to last week’s vaccine news. Interest rates rose and credit spreads gapped tighter. Notably, despite Friday’s all-time high close in the Russell 2000, long-bond yields remained 10 bps below their levels early in the week and closed below the false breakout highs from June. Last week’s steepening was modest (2yr +3, 10yr +8, 30yr +5) compared to the equity reaction, a sign to us that the bond market had gotten ahead of itself with the reflation trade in the past few weeks. It will be very hard indeed for rates to go higher under the Fed’s current interest rate policy.
Credit markets logged another good week (Investment Grade spreads -3, High Yield -7). Last Monday the Bloomberg Barclays High Yield Index touched its lowest yield on record, although yields and spreads climbed higher throughout the week. High Yield spreads are back to their late-February levels, and while policy will likely keep them tight, we think there is better risk/reward to be had in other areas of the fixed income market.
U.S. CPI inflation, released last Thursday, showed that prices were flat month-on-month. The messaging from Federal Reserve members is more of the same – pleading for fiscal stimulus and warning of downside risks to the economic outlook. If anything, the size of the next fiscal package just got smaller after the back-to-back blockbuster vaccine trial readouts. And with a very weak outlook for inflation, the Fed will be at zero for a long time to come.
What to Watch This Week
- Covid – Restrictions are coming, but the devil is in the details: how many and how restrictive, and whether it curtails the states with the biggest GDP contributions. This could inject some volatility into markets – a back-to-normal trade in the markets will not be without setbacks.
- U.S. Retail sales – Expected to increase but at a slower pace from September. The consumer continues to exceed expectations in this recovery.
- Fed speakers – Will they act in December? The asset purchase program has more questions than answers at the moment, and the ECB is set to deliver a big easing package. With stimulus on hold and lockdowns coming, they may feel pressed to act.
- Equity internals – Can stocks rally with investors rotating out of big tech? Will extended positioning cause a short-term correction? Can investors look through targeted lockdowns across the nation?
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