Market Insights: Treasury Turmoil

Macroeconomic and Market Developments:

• North American stock markets were volatile this week but ended up positive by the close on Friday after a strong finish to the second half of today. In the US, the Dow Jones Industrial Average was up 1.82% and the S&P 500 was up 0.81%. In Canada, the S&P/TSX Composite index increased 1.78%.
• The Canadian dollar moved higher this week, finishing at 79.0 cents from 78.65 cents last week.
• Oil prices continued their strong uptrend this week with US WTI crude finishing at $66.25 this Friday vs $61.65 last Friday. The Canadian WCS price finished at ~$52.50 from $52.20 last Friday.
• Gold prices continued its downtrend this week, finishing at ~$1,696 vs ~$1,729 last week.
• As expected, House passed $1.9T coronavirus relief package last weekend. From there, it will head to the Senate for debate and potential deal-making between the Democrats and Republicans. Biden still intends on signing the final bill before the expiration of extended benefits on March 14th.
• Statistics Canada published real gross GDP grew 2.3% in Q4 2020. At an annualized rate, Q4 GDP rose 9.6% beating consensus of a 7.5% rise. For the full year 2020, real GDP shrank 5.4%, the steepest annual decline since quarterly data were first recorded in 1961.
• The US The ISM Manufacturing Index rose to 60.8 in February, easily beating the consensus expected 58.9 (levels higher than 50 signal expansion; levels below 50 signal contraction). The major measures of activity were all higher in February, and all stand above 50, signaling growth. The new orders index rose to 64.8 from 61.1 in January, while the production index increased to 63.2 from 60.7. The supplier deliveries index moved higher to 72.0 from 68.2, and the employment index increased to 54.4 from 52.6 in January.
• The Canadian housing market remains strong. Both Toronto and Vancouver set new records in February and Toronto's average home price topped $1M. In terms of sales activity, the Greater Toronto Area counted 10,970 sales in the month of February, which is a 52.5% increase when compared with last February. Also, Statistics Canada reported building permits rose 8.2% to a record $9.9B in January, topping the previous record of $9.6B set April 2019, with gains primarily driven by the residential sector.
• This week, the US released the ISM Non-Manufacturing (services) index declined to 55.3 in February, lagging the consensus expected 58.7. (Levels above 50 signal expansion; levels below signal contraction.) The major measures of activity were mostly lower in February, but all stand above 50, signaling growth. The new orders index fell to 51.9 from 61.8 in January, while the business activity index declined to 55.5 from 59.9. The employment index moved lower to 52.7 from 55.2 in January. The supplier deliveries index rose to 60.8 from 57.8.
• The US released a very strong February jobs report on Friday. The Labor Department reported that nonfarm payrolls increased by 379,000 for the month compared to expectations of a 210,000 increase. In addition, there was an upward revision of 117,000 jobs for January. The unemployment rate fell to 6.2% compared with estimates for the rate to stay flat at 6.3%.
• Total global cases of COVID-19 finished this week at 115.9 million, with the total deaths at 2.58 million. In Canada, total cases now stand at 878,391, with active cases at 29,903. In Alberta, total cases are 134,785, with active cases of ­­­­­­­­­­­4,613.
• For a deeper dive, the US investment company First Trust has put out a US COVID-19 Tracker. Click here: COVID TRACKER

Charts of the Week:

We discussed long-term interest rates at length last week with multiple charts on the subject, but we will show a couple more charts today as the decline in long-term bond prices has continued and is likely the main culprit in some significant volatility and sector rotation occurring underneath the surface in the equity markets. The U.S. 10-year Treasury yield hit a new 52-week high today of 1.63% which has been quite the move since bottoming out at just 0.4% back on March 10, 2020. As a quick refresher, bond yields and prices have an inverse relationship, so when interest rates rise the price of the bond you own generally declines, and these declines are more substantial with the longer-term maturity and lower coupon you own.

We have been wary of this issue since last year, specifically targeting our fixed income exposure more towards lower duration and higher yield corporate credit. Although this didn’t allow us to keep up with the broad bond benchmark last year, which is heavily weighting towards long-term government bonds, we didn’t want to chase the yield race to the bottom, preferring to stick to our long-term process, and we have been rewarded for this fixed income positioning so far this year. With interest rates rising rapidly (even though historically they are still at a low absolute level), growth stocks have taken it on the chin of late. There is now a 10%+ outperformance gap of value-over-growth as exhibited by the Russell 1000 Value Index vs. Russel 1000 Growth Index which are the 1000 largest value and growth stocks in the US. After today’s close, the value index is up 7.43% and the growth index is down over 2.65% YTD. Meanwhile, the widely followed NASDAQ 100 (US large cap technology index) is now down 1.7% YTD, with mega-cap names Apple and Amazon down 8.5% and 7.9% respectively this year.

However, if one thinks it has been a bit of a rough stretch for growth stocks, just take a look at the Treasury market, which many view as the “safe haven” of a portfolio and part of a balanced portfolio to offset short-term declines in equities. In normal environments of the past ten years, when equities correct, you generally see a drop in long-term treasury yields resulting in a price increase, helping to offset the price decline of equities. For an asset class that is supposed to act as a ballast in a diversified portfolio, this year’s reflationary environment has put a hole in the hull of many traditional portfolios. As yields have surged this year, Treasury prices have plummeted. On a total return basis, as measured by the BoA Merrill Lynch 10+ Treasury Index, long-term bonds have been down more than 11% YTD on two separate occasions over the past two weeks. This is the third steepest maximum YTD drawdown since 1988, and we are not far off the decline in 2013, also known as the “Taper Tantrum”. The largest overall decline was in 2009 when rates rose rapidly coming out of steep recession as economic growth accelerated. However, the price decline this year has been the most rapid to start the year with the 10%+ drop first occurring in late February, whereas previously the earliest long-term US Treasuries reached that threshold before was in late April (2009).

              Source: Bespoke Investment Group

The following chart is the total return of the US 10-year Treasury (or proxy) index in Jan/Feb each year. This year’s price decline in long-term bonds is the third worst start to a year since 1830! You read that correctly, 1830. While our data clearly doesn’t go back that far, we sourced this from Deutsche Bank, specifically Jim Reid, their Head of Global Credit Strategy. We may be a bit skeptical of the accuracy of any data going back to the 1800s, but we will trust that Deutsche Bank has vetted their numbers. As we mentioned last week, rising rates can shake equities up in the short-term, but they are not necessarily a negative for equities in the intermediate to long-term, as it generally indicates accelerating economic growth which is what most of the underlying data is currently showing us.

                        Source: Deutsche Bank, Global Financial Data (GFD)

 

Sources: CNBC.com, Globe and Mail, Financial Post, Government of Canada, Johns Hopkins University, oilprice.com, Canaccord Genuity, Tony Dwyer, Bespoke Investment Group, Deutsche Bank, GFD