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Weekly newsletter |26 March 2021| One thing the market has almost forgotten about

Aarinder Lidder - Mar 27, 2021

Welcome to our weekly newsletter, where I talk about what's been going on in investment markets and what to look out for in the days and weeks ahead. Last week my newsletter was about these central banks and it was a key week in terms of central bank announcements. The Bank of Japan and the meeting from the Bank of Canada largely passed without much impact on markets. It was always going to be that the US Federal Reserve and Jerome Powell were going to be the highlight of the week and would likely have the biggest impact on investment markets, which they ultimately did.

The decision by Jerome Powell and the US Federal Reserve was to  effectively not do much and keep things as they were in terms of monetary policy. The investment markets were looking keenly at what was written in those minutes and what Jerome Powell said after the announcement. Jerome Powell went to great pains to emphasize the fact that the US Federal Reserve wouldn't be doing anything and wouldn't be rushing to unwind QE or raise interest rates. He was telling the market everything that it wanted to hear.

In fact, he was very dovish which caught the market slightly by surprise. If you look at what the markets did in the immediate aftermath of those, it's very interesting to see the dynamic in the correlations between different asset classes. You would have seen that the gold price jumped 1% in the immediate aftermath of that announcement. In the hours that followed, we saw technology stocks pick up, not massively but we saw about a half a percent rise in several the big tech stock names. We saw emerging market assets do quite well because the dollar weakened. When the dollars weak, that tends to be good for emerging market assets. We saw some of the reflation trade winners underperformed slightly on a relative basis. By Thursday the market tone had changed quite a bit; the market had digested what Powell had said. They hooked onto the fact that inflation would be allowed to run a little bit hotter for a period.

The reflation trade was well and truly back on. What it meant is we saw a big spike in the 10-year U.S. Treasury yield. That was one of the key indicators I said to watch after the press conference was made, in the days that followed. We saw the US 10-year Treasury yield jumped from around about 1.66%-1.68% at the point just before Jerome Powell spoke. Within 24 hours it jumped about 1.74%. It was a big leap in the 10-year US treasury. It was a 14-month high. You could argue that Jerome Powell had made a bad situation far worse. We saw the NASDAQ 100 fall 3% on Thursday. Conversely, we saw the Dow Jones do well on a relative basis.
The reflation trade was well and truly back. We saw the dollar strengthen which is always bad news for emerging market assets. We saw the winners that we've experienced since mid February, when the reflation trade in bond yields really started to become at the focus of investment markets. Those winners start to do very well again and those that had been underperforming during that period, namely technology stocks, they started to lag.

Moving into this week, it's as if the market has suddenly remembered something it had forgotten about. That something is the pandemic. We've had a positive roll out in Canada of vaccinations and in the US. That's why the reflation trade has really taken hold of investment markets. The consensus is that economies will start opening. Therefore, we're going to see a big boost in economic growth but there’s been rising cases of Covid in Europe. We've started to see lockdowns in France and Italy and threats of lockdowns in Germany. There is obviously the row over the export of vaccinations from Europe to the UK for example. As a result, this has started to put under threat our own vaccination program due to Canada recently agreeing to buy 21 million Astra Zeneca vaccinations. This is all started to raise concerns in investors mind, whether the pandemic is going to come back.

You are continually getting news from places like India where they have found knew variants of COVID-19. Suddenly the market this week is taking a step back and thinking perhaps they need to be a little bit more concerned about the pandemic. Maybe they've got ahead of themselves.

We have to see how that pans out in the days and weeks ahead but what it means is those pandemic winners, so were talking technology stocks. These have done very well. Those reflation trade winners such as energy stocks and financials have done badly in the last few days.

You'll start to notice that the NASDAQ is trying to play a little bit of catch up with some of the broader indices such as the Dow Jones or the S&P 500. It still got some way to go. If you look at the market overall since the start of the year, then most indices are still in positive territory. This is despite the pullback that we've seen. The pullback has been focused primarily on emerging market assets. It's been primarily on technology stocks. If you've held those and of course government debt, those are the assets that have underperformed since about mid February. Some of those were coming from high basis. Asian stocks were up double figures percentage wise by mid February, since the start of the year. That's why they're still in positive territory. Will we have a turn around in some of these assets in the next days and weeks ahead, we’ll have to wait and see.

On top of that, the Biden administration has met for the first time with Chinese officials. That meeting by all accounts didn't go well. That's why we've also seen some strain and downward pressure on Chinese stocks this week. Overall, the reflation trade is still there and it's what's driving markets. The question marks are starting to be raised over these concerns with the pandemic, COVID-19 and lockdowns particularly in Europe. Now if you wrap all that up it's perhaps not surprising that the VIX is down to around about 20, that's the fear index which is a measure of absolute future volatility expectations in the S&P 500. It's a good indicator of fear in markets. It’s still around 20, which is a long-term historical average. It broke down below 19 this week and the VXN which is the equivalent for technology stocks is down to about 28 which when it was above 31 that was obviously when we were seeing spikes in volatility.

The general fear in market isn't extreme, the greed isn't either- in fact, it's fairly neutral and that perhaps is reflecting what we've seen in markets since the start of the year. We’ve seen some strong rallies and pullbacks but a lot of markets particularly in America are still near all-time highs so now the market isn't panicking. We will have to see what happens with bond yields; this week we are seeing the opposite occur and the 10 year yield has dropped which has been good for bonds.

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

Kamal and Indy Lidder