Rising Yields Cap a Positive Month with Volatility

U.S. equities rose in February overall despite the decline during the final week of the month. These gains were a continuation of the new bull market driven by an optimistic outlook on economic recovery along with significant momentum trading. Stocks fell in the final week due to government bond yields rising to their highest levels since before the pandemic. This had an adverse effect on equities because higher yields provide a more attractive alternative to equities. Since yields had stayed low throughout the bull market, investors in search of yield were forced to look to the riskier equity market, further boosting equity prices. With yields moving higher, this trend could slow. Additionally, the improving economic picture and rising yields caused worries of a future rise in inflation. The Federal Reserve would have to raise interest rates more quickly than anticipated, increasing the costs of corporate lending and potentially hampering current economic upswing.

The equities that were hit hardest by the reaction to higher yields were large-cap and technology stocks. Both have been the largest benefactors of momentum trading since this most recent bull market began. But with their valuations stretched, these groups may be the most vulnerable to the relative attractiveness of bonds. If so, value and smaller-cap equities may catch up to large-cap and technology stocks. Both the S&P 500 Value and S&P 500 Equal-Weight indexes outperformed the cap-weighted S&P 500 in February.

Data released during the month indicated that the U.S. economy is indeed recovering. U.S. household income increased significantly in January, though almost all of that increase was a product of fiscal stimulus. Consumer spending did increase as a result, which is an encouraging sign for economic growth. The road to a full recovery is still long, but rising spending is a good sign for the remainder of the year.

Moving into March, we are encouraged by the strengthening macroeconomic indicators and the possibly positive impact of another fiscal stimulus on the economy and markets. The boost in yields substantiates the strengthening economy, but the inflation risk associated with it will be a development to closely monitor. Unmoved by these events, the Federal Reserve has remained unconcerned and committed to their plan of keeping rates low for the long-term. Yields have cooled in recent days, but pressure will mount on the Fed if they begin to climb again. While inflation risk does not appear immediate, it could still affect sentiment and the momentum that has been driving much of the market movement.

By the Numbers (Year-to-Date)*

U.S. Equities (S&P 500 Index) | 1.6%

International Equities (MSCI ACWI ex-U.S.) | 2.2%

U.S. Bonds (Barclays U.S. Aggregate Bond Index) | -2.2%

Global Bonds (JP Morgan Global Aggregate Bond Index) | -2.6%

The NorthCoast Navigator is a market barometer displaying NorthCoast's current U.S. equity outlook.  This aggregate metric is determined by multiple data points across four broad market-moving dimensions: Technical, Sentiment, Macroeconomic, and Valuation. The daily result determines equity exposure in our tactical strategies.

As of 2/28/2021. Data provided by Bloomberg, NorthCoast Asset Management.

*Source: Bloomberg, WSJ, NorthCoast Asset Management.

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