After an early February that saw many equity markets soar to new highs, the back half of February into March has seen those early year-to-date gains evaporate in a selling spell that looks to be the first material equity markets pullback of 2021. The culprit? A relatively rapid rise in bond market interest rates, especially in the long end of the curve, that has brought back memories of a similar yield spike in 2013, dubbed the “Taper Tantrum”, that spooked markets then and has apparently prompted a similar reflexive selloff in equity markets this time.
The big difference between these two episodes, 2013 and now, is that the former was prompted by communications at the time from the U.S. Federal Reserve that they were going to “taper” their Quantitative Easing (QE) program (thus the moniker “Taper Tantrum”), an asset purchase program which the bond and equity markets had seemingly become rather enamored with, if not dependent on. This time around, the spike in yields seems be the product of genuine expectations of rapidly accelerating economic growth in the second half of this year alongside pandemic restrictions being ultimately lifted. Moreover, plans for continued governmental financial support in the face of this expected recovery are stoking perceptions of eventually increased inflation, all while central banks, and especially the U.S. Federal Reserve, remain steadfastly accommodative in supplying liquidity.
It is that last point regarding the continued accommodative posture of central banks that has us reassured that this recent spasm in rates and its short term destabilization of equity markets is more transitory and should be looked through as a bump in the road to a continuingly improving economic backdrop and risk asset markets. If anything, because the rise in interest rates is normally most acutely felt by long duration assets (simply put, assets with more backloaded cash flows such as longer maturity bonds, growth stocks, and precious metals), it is no surprise that we are seeing the pullback most concentrated in those assets. Moreover, as growth sectors have enjoyed strong outperformance for so long and in some cases have seen near logarithmic moves more recently (i.e. Tesla), their sheer size and concentration in markets creates the appearance of greater volatility in price action of the broader indices than what is seen from breadth measures such as the advance/decline of index constituents.
As we have mentioned in prior missives, one of our foremost concerns with respect to our asset allocation and risk posture are the various indicators of credit conditions we follow. Credit spreads remain tight, the yield curve steepening, and central banks remaining accommodative in action and forward posture. All measures that point to constructive conditions for risk markets for the medium term. Consequently, we will maintain course through this patch of rough water to what we expect are smoother seas ahead.
