Between the end of last year and mid-February, the market hit a series of all-time highs.  Even with optimism over the prospects for enough vaccine for all Americans by June, the mood of the market seems to have dimmed over the last few weeks. Does this shift suggest we have seen the highs for the year and should prepare for lower markets ahead?  I do not think so.

  • As I have said before, market pullbacks (down 5-10%) are fairly common, occurring on average three times per year. Before Friday’s recovery, the S&P 500 was down around 5.5% from recent highs. The previous pullback was last October/November, so the timing of this one is not particularly surprising.
  • Markets often get choppy and move sideways after hitting a series of all-time highs. These periods of consolidation tend to be healthy for the market in the long run.

Even though I do not think we are in for a major downturn, there are a couple of things happening now that warrant attention. One is rising interest rates. Even though the Federal Reserve has committed to keeping short-term interest rates low for a long time, they cannot exert as much control over longer-term rates. With the prospect of an economy that may boom as the pandemic wanes later this year, the interest rate on the 10-year Treasury bond has increased from less than 1% to over 1.5% over the last few months. Even though these levels are historically low, that move is still substantial.

The last time we saw the 10-year Treasury make this kind of move higher was from July – December, 2016.  Over that time period, the market was essentially flat. Interest rates stabilized in late 2016 and early 2017 and the market moved higher for much of the remainder of 2017 as economic activity picked up as a result of corporate tax reforms. If we see interest rates stabilize over the coming weeks and months, that may bode well for the market’s ability to move higher on the back of a post-pandemic economic rebound.

The other change we are seeing now, is a pronounced shift in performance across various sectors of the market. As you may remember, I wrote several times last year about the outperformance of Technology and Consumer Discretionary compared with other economic sectors and how that outperformance skewed the performance of the S&P 500 as a whole.

So far this year, those two sectors are significantly underperforming Energy and Financials. But since Energy and Financials make up a much smaller portion of the S&P 500 than Technology and Consumer Discretionary, the result is a market pulling back from all-time highs. In the chart below, you can see the sector returns as of last Friday (1-week and Year-to-Date).

So far this year, Energy is up over 40% and Financials are up 14.4%; conversely Technology is down 1.1% and Consumer Discretionary is down 3.3%. This rotation is not particularly surprising as investors sell some of their winners and position portfolios for opportunities that may come with a more open economy.Whether this rotation continues and where the market ultimately goes in the latter half of this year may be dependent on whether interest rates stabilize or continue higher.  I will be watching that closely, along with whether corporate profits are impacted by the interest rate environment later this year.

If you have questions or would like to chat, please let me know.