Retail sales (+5.3 percent) and durable goods orders (+3.4 percent) have recently met or exceeded estimates. Notably, personal income increased by 9.5 percent in January as a result of $600 stimulus checks and increased unemployment benefits. By mid-March, more stimulus with wide support for individuals, local governments, and vaccination distribution is expected.
While shares were broadly bullish in February, it was intriguing to see which sectors performed the most, as investors questioned whether businesses that drove the markets in 2020 would continue to do so in the future. In recent weeks, value sectors such as energy (+22%) and financials (+11%) appeared to distinguish themselves by outperforming growth equities.
While emerging markets reported small gains in February, developed foreign markets remained approximately in line with US stocks, with post-Covid reopening the driving force. Surprisingly, despite a lower vaccination rate, Spain (+5%), France (+5%), and Italy (+6%) were the top-performing markets.
Interest rates in the United States jumped dramatically in February, causing financial markets throughout the world to tremble. The 10-year Treasury yield has climbed by nearly one percentage point this year, to 1.5 percent, with majority of the increase occurring in February. TIPS yields rose alongside Treasury yields in the recent jump, indicating that investors are pricing in less accommodative Fed policy sooner than expected.
Managed futures strategies have led the way in the liquid alternatives field year to date, as trend followers profited from forecasting increasing interest rates and a rebound in commodities. Hedge funds rose in February, aided by greater levels of mergers and acquisitions in recent months and the ongoing recovery in equities markets.
The Covid-19 immunization rate, which is improving (though unevenly) after early hiccups, will continue to support US economic recovery in 2021. With this context, it is not surprising that US interest rates have begun to rise dramatically, as we predicted them to do throughout 2021. However, the rate of rise in rates has been somewhat startling, and it serves as a reminder that a well-diversified portfolio must contain income sources that are less subject to increasing rates.
For various reasons, investors are justified to be concerned about rising interest rates. First, given the recent run-up in stocks and other risk assets, a substantial rise in interest rates could cause a repricing in the equity markets. Unprecedented monetary and fiscal stimulus has led investors to explain today's above-average market valuations, and if interest rates begin to rise sharply again, it is natural to believe stock market values will decline.
We anticipate that interest rates will continue to climb, but not dramatically. Following a rapid rise, interest rates appear to have stabilized in early March. Given the Fed's continuous asset repurchases and lower interest rates elsewhere, we could easily see rates return to their 10-year average.
Second, the threat of inflation is prominent. At this stage, inflation expectations are usually mild, and market indicators, such as the relative TIPS yield mentioned earlier, do not point to a near-term jump. Excess capacity and a labor market that hasn't fully recovered are factors limiting inflation. While near-term inflation may be more of a speed bump than a mountain, existing and projected government spending points to a more inflationary climate at some time. As a result, as with rising interest rates, we advise portfolio positioning that can hedge against inflation.
We continue to advocate for greater equities exposure at the expense of fixed income. Our base scenario continues to be that equities will be supported by continuous, massive fiscal and monetary stimulus, with cyclical sectors sensitive to economic recovery attracting the greatest market attention. We are also reviewing our real asset allocation to ensure that we have the correct mix of exposures if inflation picks up. Furthermore, we are focusing on sourcing alternative assets to optimize portfolio risk and return characteristics.