Reflation and Rotation
JAMIE VICECONTE
CHIEF MARKETING OFFICER
CO-CHIEF INVESTING OFFICER
2 min read
This month, the two themes in our title have dominated the financial news cycle and have gained strength this year. Reflation is the general concern that all of the fiscal and monetary stimulus we have experienced in the last year will accelerate the rate of inflation now that we may be seeing the light at the end of the tunnel called the coronavirus. Rotation is the steady increase we have seen in the equity markets in demand for the shares of cyclical, financial, commodity, and, more broadly, Value and Small-size companies. The other side of that rotation is a reduction in demand for the shares of high-flying Growth companies that have dominated the Equity market’s positive performance much of the past 12 months.
In terms of the numbers for the reflation trade, this means that the longest maturity sectors of the bond markets have seen declines of close to 10% year-to-date (“YTD”). Credit sensitive sectors have seen smaller declines, with the Bloomberg Barclays Aggregate ETF (“AGG”) down 2.18%, thanks to continued demand for yield by investors and a brightening economic outlook. But a particularly poor auction of 7-year Treasury notes at month-end February is believed to be a sign of more stress to come in interest rates.
For the rotation trade, we have seen the Large-cap Growth sectors roughly flat YTD, e.g., the Nasdaq 100 ETF (QQQ) up 0.25% and even the S&P 500 (SPY) up 1.81%. Conversely, the sectors that were strong through the 4th quarter of 2020 have come into the new year on a tear. In Large-cap shares, the S&P 500 Value ETF (RPV) is up over 13% YTD, while the S&P 500 Equal-weight ETF (RSP) is up over 5%. In Small-cap shares, the S&P 600 ETF (IJR) and the Value version of that ETF (IJS) are up 14.4% and 17.7%, respectively. Even Emerging Market sectors have done relatively better YTD, up anywhere from roughly 2% to over 4%.
Overall, those return attributions meant that our core Equity exposure outperformed the MSCI All Country World Index (ACWI) benchmark by roughly 0.30% on the month for a net return of approximately 2.6%. That brings YTD outperformance versus ACWI to around 1.6%, with a return of roughly 3.5%.
While we don’t believe the Large-cap Growth sectors will falter significantly, as highly profitable global companies dominate those sectors, the retracement of sectors that have underperformed for some time is encouraging. The relative valuations of these sectors in terms of Price-to-Book and Price-to-Earnings give them additional room to run given the growing positive expectations for a post-Covid economy. We are due for a portfolio rebalancing into month-end March and would expect these trends to be further reflected in our portfolio weightings.
In line with our comments above, the portfolio's Fixed Income component returned about -0.78% for February, beating the return on AGG for the month by 0.80%. We reduced the average maturity of our Fixed Income exposures to be even more defensive. We still maintain a healthy allocation to our core tactical Multisector strategy, either through our ETF, FWDB or in separately managed account form for tax-deferred accounts. That Multisector strategy’s tactical, dynamic approach was designed for environments in the interest rate and credit markets that we believe we will be facing.
