Developed Markets Rise in February
In the month of February, international developed stock markets rose by 2.55%. The UK and Canada recorded returns of 3.59% and 5.56%, respectively. Europe ex UK and Japan lagged other markets but are now positive for the year. The U.S. market is up 1.59% YTD, with much of the return coming from outside of the technology sector. After underperforming other markets over the past five-year and ten-year periods, the UK equity market may be poised to rebound. UK valuations are near historical lows, and the country continues to work through the challenges of BREXIT and COVID-19. Financial markets will also be supported by ongoing easy monetary policy and the potential for further fiscal stimulus across the globe.
Emerging Markets Off to Strong Start
Broader emerging markets posted a 1.11% return for the month, building on strong recent performance. India and Russia recorded returns of 5.23% and 2.52%, respectively. Brazil and China lagged other markets in February. Asian emerging markets were the primary driver of strong emerging market returns. However, commodity-oriented markets may further boost emerging market returns as inflation starts to pick up.
Energy and Financials Outperform
Energy and financials recorded returns of 14.93% and 9.47%, respectively, in February. Healthcare staples and utilities lagged other sectors. The energy sector, after a difficult ten-year period and a disastrous 2020, is benefiting from an increasingly favorable supply/demand picture. Recovery in oil demand is dependent upon vaccination progress, which has picked up after initial distribution difficulties. OPEC is still cautious about implementing any production increases. Financials benefited from rising interest rates.
Value and Size Premia Outperformance Continues
In February, value outperformed growth in the large-cap space and small-cap space. Momentum recorded a gain of 1.69%. Small-cap value stocks started the year strongly and are now up 15.15% YTD through the end of the month. Relative valuations between value stocks and growth stocks are still high based on many different valuation metrics. Value-oriented sectors such as energy and financials may still have more room to run.
Value Outperforms in International Markets
In the international developed markets, value outperformed growth in the large-cap and small-cap space. Momentum recorded a return of -0.04% while small-cap emerging market stocks posted a return of 4.02% this month. The rotation from growth into value may continue as investors become wary of high valuations in growth stocks. Rising interest rates may also pose more of a risk to growth stocks than value stocks.
Short-Term Interest Rates to Remain Low
In February, the three-month Treasury bill index returned 0.01% for the month. Interest rates on Treasury bills and money market funds are close to 0%. The Federal Reserve indicated they will keep interest rates at current levels until inflation picks up. Savers may face low short-term rates for a long period of time, which will negatively impact retirees and people close to retirement. Real yields, meaning yields adjusted for inflation, are in negative territory. The CPI decreased by -0.80% through the end of January.
Fixed Income Hurt by Rising Long-Term Interest Rates
The returns of deflationary hedges were primarily negative for the month. Long-term government bonds returned -5.51% in February after long-term rates continued to inch up. They are now down approximately 9% for the year. The Bloomberg Barclays U.S. Agg Bond Index returned -1.44% in February. Leveraged loans and high-yield bonds are positive for the year, but their higher credit risk makes them more vulnerable during economic downturns. Real yields on many fixed income investments remain negative or close to 0%.
Crude Oil Continues to Rally
Inflation-sensitive investment returns were mostly positive for the month. WTI crude oil and natural gas were up 18.11% and 9.30%, respectively. Inflation-indexed bonds dropped as their higher durations proved to be a headwind. Gold bullion dropped 6.49% in February and is now down 7.67% for the year. However, ongoing large fiscal deficits, high debt levels, and easy monetary policy may create tailwinds for gold investors in the coming years.
U.S. Dollar Depreciating
Over the past three months, the U.S. dollar depreciated against most other major currencies. The U.S. dollar depreciated against the British Pound, the Canadian dollar, and the Australian dollar the most. The Swiss Franc was flat against the U.S. dollar. The continuation of large U.S. fiscal deficits may weigh on the U.S. dollar in the medium-term to long-term.
Brandon Yee, CFA, CAIA – Research Analyst
Brandon conducts investment due diligence for Versant Capital Management, and designs and implements tools and processes to support the firm’s research. His background in biology and finance help him to look at challenges from multiple angles, resulting in unique and well-rounded approaches and solutions.
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