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Weekly newsletter | 5 March 2021| Rinse and Repeat

Aarinder Lidder - Mar 06, 2021

This week’s newsletter is titled rinse and repeat because of what we are seeing in terms of behavior in investment markets, equity markets and bond markets. In the previous week’s newsletters, we've been talking about how the yields on the 10-year US Treasury had been rising and the knock-on impact for equity markets. Initially the equity markets were sanguine about the whole affair and the yields were starting to pick up. That then started to spread globally, and equity markets started to take note. We saw some weakness in equity markets starting to spread.

If you've been keeping an eye on equity market you would have seen the nervousness pick up and equity market started to weaken even further. A good example is if you look over towards Asia at the back end of last week, we saw Asian stocks sell off 4-5%. The Japanese stock market fell as much as 4% in a single day at the back end of last week. The NASDAQ fell about 3.5%. Equity markets were becoming increasingly nervous about this bond sell off. The weekend couldn't come soon enough. The only place you could have really been and not be losing money was cash.

If you looked across the various mixed sectors or if you look at unit trusts, there were various sectors that have different allocations to equities. They will have, for example, 40-85% exposure to equities. We have other sectors that have between 20 and 60% exposure to equities. What is interesting, is if you compare the performance of those sectors in the back half of February, they've all fallen in parallel. What usually happens in the sell off, is that the portfolios with the biggest equity exposure tend to fall the most. It makes sense if there's an equity market sell off. Portfolios that have the biggest exposure to equities will drop the fastest.

What we've seen in the last two weeks is because the sell off has been centered around bonds. It's leaked over into equities; bond markets and equity markets have been falling almost in tandem. If you look at those different portfolios with varying bond and equity exposure, they're all pretty much falling in tandem. Your bonds in your portfolio aren't providing the protection they usually do in this sell off. This is because the epicenter of the angst has been bond markets. You can see the fear in markets had picked up by the end of last week. It hit the VIX, the market fear gauge had hit 28. If you looked across to the VXN, which measures the same kind of fear, but in the tech heavy NASDAQ. That pushed up towards about 36 which is a very high number. Much more stress than what we saw in the normal VIX, which is a measure that relates to the S&P 500. This is a wider stock market index, so fear was creeping into the market. The weekend came along, we got into this week and it was a new month.

Everybody was far more optimistic and yields started calming down. The central banks such as the US Treasury, started making noises towards the fact that they were watching what was going on in bond market. We even saw the central Bank of Australia act and start buying bonds to try and calm the jitters in their domestic bond market. Overall to start this week, we started to see bond markets calm down a bit. Yields started folding which means that prices of these bonds like the 10-year US Treasury note for example started to rise. That obviously enthused investors and we saw equity markets rebound, especially the areas that sold off the most in the previous week. On Monday for example, we saw the S&P 500 rise by 2.37% in a single day. We saw strong moves in pretty much every equity market globally. Technology stocks and individual technology stocks that we saw the biggest rebound. If you looked at Tesla for example on Monday, the share price rebounded over 6%. There was a sense that perhaps this episode in bond markets was over.

However, as the week progressed, we started to see a repeat of what we've seen in the previous week. Whether it's fears over different variants of the Covid vaccine that were coming about, (the Brazilian variant has now been found in various countries), fears over a potential bubble forming in technology stocks with very high valuations, or the fear of rising inflation, we saw a repeat of the stock market wobble. It was really all about bonds. The other factors such as the coved variance were taken backstage. It’s the bond markets that's once again causing stress for equity market.

We are in another risk off sentiment. The NASDAQ has broken down below its 50-day moving average. Moving averages are support lines that some technical investors look at. In very simple terms, it takes the average of the previous 50 days prices in the index. It provides a general sense of direction. If a market breaks down below the 50-day moving average for example, that shows there's been a definite change in short-term trend. Some people use that as a sign as there are going to be more weakness to come.

Where does this all leave us because we're now back in a scenario where bond yields are rising? Last week the 10-year US Treasury yield got to 1.5%. That is a key level when it broke up above that, that's what really spooked the market. That was an old resistance line that suggests that if it's broken, there could be more upside to yields. Perhaps going as high as 1.8% in the short or medium term.

That would mean that bonds would continue falling and that could put more pressure on equity markets. Don't forget though that the real angst has come from the speed of rising yields, rather than just the fact they are rising. The market is pricing in a more optimistic outlook for the economy. It's the pace of the rising yields and the pace of inflation that they're concerned about. That’s causing this rapid repricing in bond market and therefore equity markets in particular technology stocks. I explained last week they are sensitive to rise in yields.

It’s interesting that we’re seeing other assets like gold, which is getting hammered now. This is due to the rise in real yields. It's now falling towards the $1700 level per oz. That is a key level; if we break below that there's a very good chance that the price of gold could unravel down towards maybe $1500 per oz. It's a line that you want to keep an eye on. Its been an historic line of support that markets tend to rebound from. Let's see what happens going forward. Overall, the market is in a position now that we're seeing some broad weakness in markets. There are some areas that are very stressed. Technology stocks is a prime example and we've seen a rotation into value stocks.

As I mentioned last week, it’s a pattern that was seen at the beginning of November, when we had the vaccine trade. There are days when the technology heavy NASDAQ is falling 2% but the Dow Jones is positive. That is very unusual, but it's showing there's a rotation from these expensive growth stocks into stocks that are now seen as value plays in an economy that's opening. That is a rotation and rotations aren't the worst thing in the world for a stock market and even a bull market. You can see this isn't a correction across equity markets. In fact, many markets are not a million miles from all time highs or multi year highs. In areas there are stress, so technology stocks for example is the main one. Your seeing that play out in funds within your portfolios. The question becomes will we see a bounce back particularly in tech stocks. Normally when they get down to this of level, towards the 50 day moving averages which they've broken through, then there's been a quick rebound in recent history.

Normally this is because the Fed has stepped in. We’ve got to see what happens, but overall, on your portfolio you're probably looking at values that are falling and wondering what's happening. Pretty much everything's fallen; even commodities are starting to show signs of weakness. They have been one of the best performing asset classes year to date. They still are up year to date. This is even though golds falling about 8%. The message for this week is we're seeing a repeat of what we've seen in the last couple of weeks. Bond yields are rising and it’s causing a lot of stress. There's not much you can do to avoid losing money other than being in cash or avoiding the most pain in key assets like technology stocks. Over the next days and weeks ahead, keep an eye on the yields, particularly the US Treasury, bond yields more generally, and of course the VIX.

The VIX, which is commonly called the market fear index - see how that's going, if that's pushing higher or not. It will be interesting to see what central banks say, what noises they make in the coming days and weeks, and whether this will therefore repair the market sentiment. At the moment, markets haven't completely unwound, it just feels like the market is in a bad place right now. Liquidity is poor, but at the moment there's a feeling that markets are trying to workout which way things are going to go where we're going to rebound or stay volatile. On another note there are compelling discounts that are presenting themselves with the recent weakness. Buying the dip is prudent in the days and weeks ahead.

Have a great weekend and join us next week for our next newsletter.

Kamal and Indy Lidder