Commentary provided by John Packs, Senior Investment Officer, AIG Retirement Services
Market Performance Snapshot (Week ending March 19, 2021 and Year-to-Date)
- Dow Jones Industrial Average®: -0.5% | +6.6%
- S&P 500® Index: -0.8% | +4.2%
- NASDAQ Composite® Index: -0.8% | +2.5%
- Russell 2000® Index: -2.8% | +15.8%
- 10-year U.S. Treasury note yield: 1.73%
- Up 10 basis points from 1.63% on March 12, 2021
- Up 81 basis points from 0.92% on December 31, 2020
- Best-performing S&P 500 sector this week: Communication Services, +0.5%
- Weakest-performing S&P 500 sector this week: Energy, -7.7%
Past performance is not a guarantee of future results.
Volatility in equities continues, as the Federal Reserve and markets battle over rates
The Dow Jones Industrial Average reached new highs during the week, before pulling back on Friday, while the NASDAQ Composite continued to lose ground. All four major indices were negative for the week. The benchmark 10-year Treasury yield kept climbing, surpassing 1.75% before ending the week at 1.73%. The Federal Reserve said higher economic growth and inflation are on the way, but the inflation will be temporary.
- The Federal Reserve’s Federal Open Market Committee (FOMC), which determines interest rate policy, met on Tuesday and Wednesday. The FOMC issued its updated economic forecasts, which now show the U.S. economy growing at 6.5% in 2021, up from a forecast of 4.2% in December. The higher growth expectation is rooted in this month’s $1.9 trillion stimulus package, continuing vaccinations, and further easing of economic restrictions.
- The FOMC also expects inflation to rise to 2.4% this year – above the committee’s 2% target – but fall back to around 2% over the next two years. Fed policymakers have already said they will be patient if inflation runs above its target for a period of time, particularly if the labor market hasn’t fully recovered. The FOMC expects the unemployment rate to drop to 4.5% by the end of 2021, but not fall to the pre-pandemic level of 3.5% until 2023.
- With inflation expected to be temporary and the labor market needing more time to recover, the majority of FOMC members said the federal funds rate will remain in the 0-0.25% range into 2023. The Fed will also continue purchasing $120 billion a month in Treasuries and mortgage-backed securities “until substantial further progress has been made toward the [FOMC’s] maximum employment and price stability goals.”
- The continuity of the Federal Reserve’s policy initially drove stocks higher Wednesday. However, the 10-year Treasury yield then rose above the 1.75% level, which took a toll on technology stocks and the NASDAQ Composite.
- While the Fed controls the short-term federal funds rate, longer-term interest rates – including the 10-year Treasury yield – are determined through market buying and selling. With markets expecting faster economic growth, higher inflation, and an increase in Treasury supply as the federal government finances its growing debt, longer-term interest rates are rising.
- Most market forecasters expected yields to rise from 2020’s historic lows, but not quite as quickly as they have. The rapid rise in yields has challenged the valuations of technology and other growth companies, which are sensitive to interest rate changes.
- Markets are continuing to ask at what point the Federal Reserve will become concerned enough about inflation to take steps to cool the economy. In the March 2021 edition of Bank of America's monthly survey of institutional investors, respondents said that higher-than-expected inflation or a potentially dramatic bond market reaction to any reduction in Fed asset purchases are the biggest risks for the market. It’s the first time since February 2020 that COVID-19 did not rate as the biggest market risk.
- The Federal Reserve has repeatedly tried to tamp down inflation concerns. Indeed, for the past decade, the Fed has been more concerned about inflation being too low rather than too high. On Wednesday, Chairman Jerome Powell said he wants to see “actual progress, not forecast progress” on the economy before changing policy. But the ongoing back-and-forth between markets and the Fed will continue to create volatility.
Just how strong is the economy these days?
Economic data on the labor market, retail sales, and manufacturing show the U.S. economy is still trying to find its footing, as it continues to feel the impact of the pandemic and remains highly dependent on fiscal stimulus.
- The latest weekly report on new unemployment claims revealed an increase to 770,000, though the figure may have been impacted by winter storms. It still underscores the challenges that continue to affect the labor market.
- Retail sales for February dipped 3% from January. However, January’s retail sales figure was revised up to a 7.6% gain, as consumers spent checks issued after the December stimulus package. Retail sales from December through February were about 6% higher than for the same period a year earlier.
- The federal government has already issued 90 million stimulus payments from this month’s package, suggesting that March and April’s sales figures should rise.
- Manufacturing activity fell in February, according to a Federal Reserve report. The drop appeared to be less about economic fundamentals than about ongoing supply chain issues and tough winter weather across the country.
- Honda and Toyota announced a production pause at North American plants in response to supply chain challenges. Shortages of semiconductors continue to bedevil car makers and other industries, while weather, international shipping backlogs, and pandemic-related disruptions also interfere with supply chains.
- Assuming that restrictions on economic activity continue to ease, markets will be watching to see if the combination of higher consumer demand and challenged supply chains leads to price spikes in parts of the economy.
Final thoughts for investors
The NASDAQ Composite, which has faced the greatest challenge from this year’s rising bond yields and rotation toward cyclical and value stocks, is still positive for the year and up nearly 93% from its low on March 23, 2020. The Dow Jones Industrial Average, which lagged last year, moved from 32,000 to 33,000 in just five trading days this month, before stepping back a bit. Rather than trying to time markets or predict volatility, stay focused on long-term goals and speak with a financial professional about the most appropriate strategy to achieve them.