STUDENT OF THE MARKET

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April 2021 highlights

MARK PETERSON: This is Mark Peterson with the April 2021 Student of the Market. Let’s begin with where we’re at so far year to date with stock and bond returns. A little bit of a disconnect there. Stocks up about six percent for the year; bonds though down 3.4 percent. This is actually a little bit of the decoupling that we haven’t seen in quite  a while, 2013 was the last time we saw bond  negative and stocks positive. And it’s only happened nine other times historically where you have bonds negative through end of March and stocks positive through the end of March. And just wanted to look at historically what that meant for the rest of the year. You can see stocks actually fared pretty well. In seven out of the other nine calendar years in which it happened, on average, up about 9.6 percent. There were two years where you had negative returns for stocks but those date back quite a way, back in 1937 and then back in 1929. There were two couple other periods where bonds actually were negative, the rest of year, both most recently 2013 but also back all the way in 1999. And then also 1955. And all three of those years, bonds finished lower the next 12 months but stocks actually did really well in all three of those years. So I think it bodes well for stocks at least by what history tells us here. Moving ahead to the next slide, looking at the anatomy of bear markets. Clearly the one year anniversary of the bear market low on March 23rd. This is a slide we did last year that got a very positive response, just detailing out some of the most recent bear markets really since 1950. Just so you can see the length, how much they were up, how much they were up one and three years after, and clearly a very unique story in 2020, very short bear market, only 23 days, down almost 34 percent but rallied one year later up over 77.8 percent. That makes it the biggest rally one year later after a bear market that we saw historically again going back to 1950. So it was the shortest and quickest recovery which I think is interesting, really the only other bear market that was even in the ballpark, short, was 1987 where it was 71 days versus the 23 that we experienced in 2020. Now looking at what has delivered returns for the US stock  market so far in 2021? It’s the exact opposite of what we saw in 2020 where the small stocks within the  S&P 500 has been the best performer. So this is something we ran last year; of course last year it was very top heavy, the top five stocks averaged 52 percent, a little bit more than 52 percent return for the year of 2020. This year it’s the opposite.  The smallest stocks have done the best. So just wanted to update that dynamic; I think sometimes we lose sight of that, what is really driving returns in the market, certainly we’ve seen the shift to small caps. We saw it in the fourth quarter of last year and it’s continued on so far this year in 2021.  Now clearly the story on the next slide is what stocks do when rates go higher? And I think this has certainly been a story so far in 2021, the back up in interest rates, some concern that that’s certainly been a little bit of drag on the stock market, really tough to see though when you look at the rate history historically, especially with long term interest rates. And that is one thing I wanted to pull out on this chart is when you look back historically going back to the early-90s when we’ve seen long-term  interest rates go up, it’s generally been pretty darn good for US stocks over that rising rate period, reflecting the fact that those rates are probably rising because the economy is doing well. Versus when we you see shorter term interest rates, specifically the Fed, raising the Fed Funds Rates. When you get into those cycles, stocks don’t fare as well in that environment. It’s not necessarily a terrible environment for stocks, but clearly puts more pressure that you’re getting closer to the end of that positive economic cycle when the Fed takes the punch bowl away. So thought that was interesting. I think sometimes we talk about interest rates interchangeably, but often longer term rates going up, a steepening of the interest rate yield curve, is a good thing for stocks. It’s reflecting a positive outlook for the economy going forward.

05:00

Versus short term interest rates and the Federal Funds Rates going up, often reflects a flatter yield curve, meaning slower economic growth anticipated ahead. So I just think it’s good to draw that distinction. I think that is really going to explain some of the challenges we have going forward with stocks. Once we get to the point where the Fed starts raising short term rates, I think it’s going to be a challenge, especially given where valuations are at. Often a flattening yield curve and high valuation on stocks just don’t mix. Now a couple quick ones on the next slide, just looking at the hold chart looking at holding period for US stocks and what percentage of those periods are positive going back to 1926. So solid 95 plus year history here of US stocks, and you can see a little longer you hold stocks, the greater percentage likelihood that you’re going to have a positive return. You move out to 16 years, and every 16 year rolling period US stocks have a positive return. 15 years almost 100 percent but you had two periods there that were negative. But  I think clearly a positive story here for stocks, owning them for the long term, nothing quite as compelling. We did the same look on the next slide, for bonds. Same story except a lot shorter time period. You move out to four years, and you’ve never actually had a four year period in which the core bond index lost money. Again, close on the three year window. You get the 99.3 percent of those periods were positive, but again, you have to stretch a little bit longer for that fourth year to get to positive returns. Now turning our attention to flows on the next slide, we spent a lot of time talking about flows in Student of the Markets, really the last couple of years. Last year especially we saw record flows in stock mutual funds and ETFs, mostly well completely, on the mutual fund side on the stock side. You had some really enormous months in which we saw outflows really following some of the volatility and concern, both in the summer and into the fall, really one of the biggest periods of outflows that we’ve ever seen in stock mutual funds and ETFs, again dominated by the mutual fund side, but really when you add i8t all up, it was pretty pronounced. And that switched in February of this year.  You actually had record inflows into stock mutual funds and ETFs. Again, dominated by equity ETF flows, but it was a record actually going back to 1993; it was the biggest month ever for equity fund flows. And the question is of course, what does this mean? It is a little bit of a bounce back. We did have a great month in November of last year and then flows turned negative again the next months. So something to keep an eye on of course, these flows tend to be a big-time contrarian indicator, meaning wherever flows are going, you’re better off doing the opposite. If you look at some of these periods where we’ve had tremendous flows on a monthly basis. The next 12 months tend to be well below average for stock returns.  I think we’ve had such outflows in stock mutual funds over the last 12 to 18 months, it’ll be interesting to see where this one goes.  This could bounce back; you could see some rebalancing at the end of March to really negate the inflows that we saw in February. It also tend to be somewhat seasonal, occasionally you’ll see beginning of the year, a big bounce in one of the months from an equity flow standpoint.  But I did want to highlight it such it’s such a dominant story certainly a ton of cash on the sidelines in money funds as well. That continues to head higher. That’ll be a positive for stock funds, certainly bond fund performance, the fact that bonds are down over there percent year to date. That is going to drag down some bond flows as well. We’d anticipate. So you could get a little continued bounce in stock flows  just based on that reality. That you’ve got a lot of cash in money funds on the sidelines; you got bond funds. Certainly posting negative returns, year to date, could push folks into the stock market. But again, something to keep an eye on here as we move forward. And then the last and final one – one of my favorite topics always – is inflation, grabbing some headlines, folks concerned about all those dollars. In the sidelines, and all the spending from the government. That it could push inflation higher.

10:00

And certainly we believe that is the case, the question is how high? And this is just a look at one of the dynamos that I think is tremendously underrated when we talk about inflation. Is the fact that they have made a change to the index, granted, it was almost 30 years ago, but I guess over 30 years ago at this point. In the early-80s, they changed out housing prices for rents. And they made this change because interest rates were falling even though housing prices might have been going up. It was actually cheaper to buy a home based on declining interest rates, and that is certainly something that has continued to happen over the years as rates have fallen. So they wanted to switch from housing prices to rents to better reflect what the home-buying experience might mean  to inflation.  And this change certainly has some unintended consequences. It has taken all the volatility out of the inflation number; housing is the biggest component of the overall index. If you look at the actual homeowners equivalent, rent of primary residence, it’s the largest number in the CPI, at 23 percent. And it’s interesting to look at the dynamic between the two. You of course have housing prices, we use the Shiller Housing Price Index here. It has been extremely volatile over the last 20 years. You look at it with excuse me, the housing bubble inflating and then bursting. And the subsequent rally that we’ve seen since, extremely volatile across the board, where you have double digit changes in prices given years; you have some years in which we had reg negative decline in housing prices, following that housing bubble in the Global Financial Crisis. Versus rents which are amazingly stable. If you look at it over this 20 year stretch, they’ve really been right in between zero and three to four percent, that’s been the range. So a pretty tight range when you look at how volatile the actual home pricing index, how much that has moved up and down. You just don’t see that in the rental space. So it’s really taken a lot of volatility out of the market. Also there tends to be a dynamic between the two that often times home prices and rents compete with each other.  And you’ll see moves where home prices and home-ownership is in vogue and folks are moving out of the cities or just moving into more of a buying situation versus renting. We’ve seen that during certain periods, and you’ll see spikes in home prices, which also keeps rents down as well. So you do get a little bit of that dynamic. I think that’s certainly happening now post-COVID this year and you can see the dynamic last year, really started to rev up, where you saw home prices increase 10.4 percent, and rents were only up about 2.2 percent, which is a pretty big gap between the two. So just wanted to highlight that reality within the inflation index that they did make the change. It’s taken out all the volatility in the inflation index going from housing prices to rents within that index. And certainly this sometimes can feel like a pretty big disconnect when you got a pretty big hot housing market, yet that market is not finding its way into that inflation number. I think it’s one reason why that inflation index has stayed pretty low and very stable. Really since the early-80s, the last time we saw periods of higher inflation. So a little bit of an inside-inflation in the weeds knowledge. But I think it’s important to understand, especially given the fact that we’re starting to see this housing price/rental differential really start to flare up here. So that is our April 2021 Student of the Market. As always, we’d love to hear feedback and ideas for content going forward. If you do reach out on our webpage, there is a spot to submit ideas and feedback. Thanks again always for your interest in BlackRock Student of the Market.

Anniversary of the 2020 bear market

The 2020 bear market lasted only 23 trading days and rebounded 77.8% over the past year, giving it both the shortest time frame and largest rebound of any bear market since 1950.

Smallest stocks are contributing the most

The largest stocks in the S&P 500 were responsible for driving index returns in 2020. The opposite has been true in 2021, with the smallest stocks driving the largest returns in the index YTD.

A comeback in stock fund flows

After months of outflows (9 out of 12 months in 2020 saw outflows), stock fund flows have set a record in February 2021 for the highest month of inflows since 1993.

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