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Weekly newsletter |12 March 2021| Relation trade here to stay?

Aarinder Lidder - Mar 12, 2021

Welcome to our weekly newsletter. I want to begin this week with the reflation trade. The reflation trade just won't go away. Within the last two weeks, I've been explaining what's been happening in investment markets in relation to the rising bond yields we're seeing on government debt around the globe but particularly in the US.
If we look at how markets have moved in the last week, you can see the reflation trade is still what is driving a lot of market moves. If we look at the last week since our last newsletter, the Dow Jones industrial average is up 3%. The S&P500 is up around about 2% in the last week. The Nasdaq 100 is up around about 2% but it was down until Tuesday.

We're still seeing a lot of those rotations out of growth and technology stocks. This is moving into more value trades, which is evidenced by the Dow Jones hitting an all time high, even though we've seen such an aggressive technology stocks sell off. Particularly, in the Nasdaq 100 over the last couple of weeks.  Large Cap stocks are benefiting from this rotation out of technology and growth stocks, into more value orientated companies. This is being driven by the rising yields we are seeing around the globe and in particular the US.

We're still seeing these divergencies. From this you can discern that if your portfolio was very concentrated in stocks in the Dow Jones and you avoided technology stocks and more speculative areas, you'd be doing well. The stocks that were doing very well leading into this year are now being the laggards. Technology stocks have endured their worst streak in six months. You can see there's a nuance to this sell off and we’re seeing a lot of weakness in Chinese equities. In just 14 trading days the CSI 300 index has fallen 14% from a 13-year high. That is happening against the backdrop of the national people's Congress. This is a closely watched political pageant. The authorities in China would not like to have a stock market collapse occur.

The fact we are seeing it is very unusual. The authorities in China did intervene in markets this week. This was via what is known as the national team. This was essentially national fans that started to buy Chinese equities when the market starts to collapse. They try and push things higher, reduce the volatility and the sell off. They've had mixed success; in fact when they first intervened at the beginning of the week, the market still turned around and fell 2%. We've seen a little bit of stability in Chinese equities. It's really Chinese technology stock weakness that we're experiencing now. It is good to  view companies like Alibaba or Tencent and look at their share prices. You can see how much they’ve fallen in recent weeks.

Although people were hoping that this week would start on a much firmer footing for global equity markets, it did start to take a turn for the worse. However, by Tuesday we saw some signs of stability; in fact, we saw the Nasdaq 100 close up 4% in a single day on Tuesday. The market has now got to a point where it can rebound. We've already hit correction territory on the Nasdaq 100. Could it be that investors are now looking for some value in those unloved technology stocks? We will have to see how it pans out in the days and weeks ahead.

One of the key things that caused the turn around on Tuesday, was a receding in government bond yields. We saw Treasury yields break back down below that 1.5% level. We have seen Treasury yields on the 10 year note in America push above 1.61%. Therefore, we saw that further weakness and this reflation trade continue. We saw commodities rise but they too started to pull back when the dollar started to rise, people go to safe haven stock and thus the dollar moves higher. We get a safe haven bid when people start to rush toward safety.

We started to get the stronger dollar play, coming to markets as well. That's another reason why emerging market assets have done particularly badly in recent weeks. We've seen the VIX, the fear index starts to breakdown aggressively below the 31 level. It’s now down to around about 22. The VXN which is the equivalent on the Nasdaq 100 was up above 36.  That’s now started to pull back down towards 31. If it keeps going below that level, in recent history that's been a key threshold where below that level we've seen strength in technology stocks.

Could we be about to see a rebound? The Chinese authorities have entered the market. The central bank for Australia tried to calm the markets a week ago. Are we going to see more central banks start to enter the market? At the moment, the Federal Reserve in the US hasn't done anything. If we do see that yields keep rising, then that could also unwind this reflation trade that we've been seeing.

Last week I drew your attention to the performance of the sector averages of professionally managed funds. They are the mix shares sector that have varying degrees of equity exposure. What is interesting, is that continues to be the case that they almost fall in tandem. If you hold a portfolio that is traditionally split between equities and bonds, then during this continued battle weakness there’s not much hiding place. You will see both parts of your portfolio falling in tandem. As I mentioned earlier, the only real place you could have hidden, is in those value stocks. We're talking about some of the smaller companies and particularly the Dow Jones index.

Last week I mentioned gold breaking down below $1700 per oz. That occurred and we started to see the value of gold fall even lower. That started to open up the door to a significant breakdown but then that rebounded, and we are back above the $1700 level. Still keep an eye on those key resistance levels on gold. All the while markets are still doing this see-sawing. We're getting relief rallies one day, for them to only unwind the next.

The message is that things could be volatile before they do get better. Will other central banks be forced to start to intervene in markets in the coming days and weeks ahead?  Keep an eye on the VIX that I mentioned. Keep an eye on it being below that key 31 level which it is now. If it continues to push lower that's obviously good for equity markets. Keep an eye on the bond yield, the 10-year US Treasury yield. Does it break back above the 1.5 level, above the 1.6 level? Will it head up towards about 1.8-1.9. level?

However there seems to be a nice move upward over the last few days. Anymore weakness is a buying opportunity as we anticipate a steady move upward in 2021.  If one positioned correctly for this then one will benefit.

Finally don’t forget to check out our website on www.liddercapital.com for more information.

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