Capital 19 Catch-Up

Rising Yields Perpetuate Market Sell-Off

We saw a bit of weakness enter US equity markets last week. The S&P500 fell 2.4% and the tech heavy Nasdaq 100 fell 4.9%.

It all came on the back of rising yields on the 10yr Bond. Last year the yield on these was sitting around 0.6%. On Thursday it rose to over 1.6%. The Fed’s overnight interest rate is still basically zero, but the 10Yr bond is used as a benchmark for mortgage and credit card rates, so has real world implications.

Economists and investment managers believe the bond market is moving on faster-than-expected economic growth as the Coronavirus vaccine rollout boosts GDP forecasts. However, the move in yields could also signal hotter inflation ahead, which could weigh on equity valuations.

However, late Friday at the close, the yield eased and Treasury prices increased, perhaps as investors found those yields attractive and rotated some money over into bonds. That kind of asset allocation behavior could also keep a lid on future rate increases.

We don’t see the bond yield moves having any long-term implications for US Stocks. It does take a little of the shine off long term plays such as technology companies but their earnings growth will overcome any interest rate fears eventually.

Last weeks moves were just your garden variety pause after a solid run higher.

Warren Buffet released his annual letter over the weekend. We like Warren and look forward to his letter every year. This year his message was simple.

“In its brief 232 years of existence….there has been no incubator for unleashing human potential like America” The Chairman and CEO of Berkshire Hathaway wrote. ‘Despite some severe interruptions, our country’s economic progress has been breathtaking. Our unwavering conclusion: Never bet against America’.

He went on to highlight two wholly owned American businesses, BNSF Railway and Bershire Hathaway Energy (BHE) – which earned $8.3 billion in 2020 despite a plunge in demand amid the Covid-19 pandemic.

And he reminded investors that miracles do occur in middle America despite much of the attention on coastal areas. “Success stories abound throughout America,” the investor said. “Since our country’s birth, individuals with an idea, ambition and often just a pittance of capital have succeeded beyond their dreams by creating something new or by improving the customer’s experience with something old.”

On the topic of investing, Buffett said ultra-low interest rates around the world diminished the appeal of the bond market.

“Bonds are not the place to be these days,” Buffett said. “Fixed-income investors worldwide – whether pension funds, insurance companies or retirees – face a bleak future.”

Buffett noted that the benchmark 10-year Treasury yield had fallen drastically to 0.93% at the end of 2020 from 15.8% in September 1981. Meanwhile, investors earn a negative return on trillions of dollars of sovereign debt in Germany and Japan, he added.

Berkshire bought back another near $9 billion of its own stock in the fourth quarter of 2020, bringing the firm’s total repurchases to $24.7 billion last year — a record year for buybacks.

Buffett has started some bargain-hunting amid the market comeback. He recently took a sizeable position in Chevron (CVX) a classic value play, while also adding Verizon (VZ) as well as a handful of drug stocks. Apple (AAPL) still ranks as the conglomerate’s biggest common stock investment, which played an important role offsetting the pandemic damage done to Berkshire’s railroad and insurance business in 2020.

Even as the buyback strategy appears to pay off, some investors looking for an update on succession or details of Buffett’s next big acquisition may come away a bit disappointed from the letter. The conglomerate is still sitting on a huge cash war chest with more than $138 billion at the end of 2020.

Warren can go shopping whenever he likes with that kind of pocket money but being a classic value investor, don’t expect him to rush out and buy the overpriced tech companies.

The tug of war between stocks and bond yields could set the tone for the coming week, particularly if positive economic data continues to push Treasury yields higher.

Friday’s February employment report is the highlight of the week’s data and an important current look at the impact of the virus on the economy, after just 49,000 jobs were added in January.  For February, economists expect to see 218,000 jobs added, and the unemployment rate should stay the same, at 6.3%, according to Dow Jones.

Fed speakers are also a major focus of the markets, after the rapid rise in bond yields this past week had the feel of a runaway train. Fed Chairman Jerome Powell is the most important speaker, when he appears at a Wall Street Journal summit Thursday.

“If he wants to stop this rise in rates, he does have to say something. But he risks sounding hawkish. The more dovish he sounds, the higher rates will go,” said Peter Bockvar, chief investment officer at Bleakley Advisory Group.

Some Fed watchers doubt the central bank will comment on the rise in yields any more than Powell did this past week when he said the move was the result of a strengthening economy. But bond pros say Powell could reinforce that Fed policy will remain easy for a long time to come. That is our view too. Powell will re-iterate his long-term easy money stance and stocks will recover most of what they lost last week.

March is actually a pretty good month for the market. It is the fourth best in terms of average price change. It is the fourth best in frequency of advancement, yet it is the fourth lowest in terms of volatility.

It is one of our favourite months to be long stocks and we are glad it has started

Until next week – stay long everybody.