Commentary Directory

Risky Assets Sell-off Despite Optimistic Economic Outlook

Jacob Hess
March 09, 2021

March has not been friendly to the stock market after an optimistic start to the year. Momentum from vaccinations was pushing investors forward with the expectations that the economy would snap back into recovery in 2021, but those expectations were paired with a strong rebound in Treasury rates which has spooked the market into fearing higher inflation and a Federal Reserve that will allow interest rates to rise in response. The Fed, however, has indicated that it plans to remain accommodative in the near term to support the quick recovery.

The moves in bond yields so far this year have been large and have lead to risk-off moments in equities. January was a relatively calm month with the 2-year Treasury yield flat, risk assets rising, the Nasdaq up 5.6% and the S&P 500 up 2.0%, and value stocks lagging, the Dow Jones Industrial Average flat. The stock market seemed to be following the trends of late 2020 trading. However, the trends broke with moves in yields. The 2-year yield rose 18.2% in February and 30.8% so far in March shooting off lows that had been established by highly accommodative monetary policy and deflationary forces from the pandemic. Over February and March, the Nasdaq has lost -5.9%, the S&P 500 about flat, and the DJIA up 5.3% as risky assets start to correct.

Trading has been representative of a trend of diverging performance between value and growth stocks since the pandemic began. Using the S&P 500 Growth ETF (SPYG) and the S&P Value ETF (SPYV) as representatives of these two classes of assets, one can see a longer-term trend of divergence from late April 2020 to March 2021. The correlation has spiked lower 3 times in the past year in periods of strong divergence. Even after those spikes, the relationship between growth and value remained choppy and struggled to surface above 0.80. So far in March, another correlation spike is developing with an 0.38 correlation coefficient in the first 8 days of trading.

Moving 30-day correlation between SPYG and SPYV.

Risk-off has not been the only theme of the sell-off. Investors seem to be rotating into sectors that haven't seen the joy that risky assets saw in 2020. The Energy and Financial sector, sectors that were negative in 2020, are both up strongly over the past month where Technology is hurting. Industrials and Basic Materials have also been solid over the past 30 days. Some of that is likely a result of inflationary pressures pushing up raw input material prices proving to be profitable for firms selling those inputs. Oil and gas prices, in particular, have gained steam leading to gains in the Energy sector.

Many will say that the correction was due, but that doesn't mean the volatility hasn't come at an awkward moment. The Federal Reserve has confirmed its strong commitment to accommodative monetary policy. The $1.9 trillion stimulus is on the verge of becoming law. GDP estimates for 2021 for advanced economies are some of the strongest in recent years. High rates of savings look to bolster consumption in the near-term as lockdowns ease. Everything points to a healthy environment for risk. However, that could also be the problem. An overheating economy leads to stronger cyclicality and an inevitable contraction. That could be a fearful catalyst because the Fed has indicated it intends to smooth out cyclicality as much as possible. If belief that central banks cannot do this diminishes, so will appetite for risk.