February Market Insights – Energy and Financials Fuel February’s Markets

Index Performance

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US and International Equities

This month provided positive results for the major market indexes. The top performer was the Russell 2000 small cap index, returning over 6% for the month. Small caps continue their ascent higher from their robust 2020 fourth quarter finish. Developed international markets, as denoted by the MSCI EAFE, were over 2% higher for February.

The Rise of Emerging Markets

Even though the emerging markets performed marginally in February, they have had a solid start to 2021. The MSCI Emerging Markets (EM) index has returned almost 4% for the New Year, more than doubling the return of the S&P 500 so far year to date.

LPL Research is positive on the emerging markets. “We expect solid economic growth across Asia to support outperformance by emerging market equities over developed markets in 2021,” noted LPL Financial Chief Market Strategist Ryan Detrick. “Also consider that US-China tensions may ease under the Biden administration and a weaker US dollar may potentially enhance returns for dollar investors in emerging markets.”

Energy Powers Forward

The energy sector, which started its rebound during the fourth quarter of last year and continues to lead all sectors as 2021’s top performer, continued its winning ways returning over 22% this month. The global demand outlook has improved as the COVID-19 vaccine rollout has picked up speed recently and we get closer to a fully reopened economy.

Financials also had a strong month, returning over 11%, bringing the sector’s year-to-date return to almost 10%. Financials have been beneficiaries of both strong equity and credit markets along with rising interest rates and a steepening yield curve.

The major sector underperformers this month were utilities, consumer staples, and health care.  All three sectors are lagging the S&P 500 so far this year.

Earnings, Earnings, Earnings

One major factor influencing markets recently is fourth quarter earnings. With a majority of the S&P 500 Index constituents having reported results, the index’s earnings growth for the fourth quarter of 2020 is tracking to a more than 3% year-over-year increase. This is roughly 12 percentage points above estimates as of January 1, 2021.

The sectors seeing the biggest upside surprises include communication services, consumer discretionary, and financials. Forward 12-month estimates have impressively increased about 4% year to date since earnings season began.

Japan’s Nikkei tops 30,000

The Japanese Nikkei recently topped the 30,000 mark. This is the first time that the Japanese headline index has seen that level in over 30 years. That being said, the Nikkei still has a ways to go in order to reach its all-time closing high of 38,915.87, which it achieved on December 29, 1989.

Market Sentiment

In general, equity investors have become quite bullish given fourth quarter earnings reports, a robust housing market outlook, and the improving economic landscape. The American Association of Individual Investors survey of bulls versus bears has been climbing, and bulls are currently outnumbering bears.  Even though the ratio is well short of the historical extremes, this is still something to monitor, especially given the rally we experienced from March 2020 to now.  For more of our thoughts on market sentiment, please read the blog post Sentiment Getting Frothy but Long-Term Bullish.

“We continue to be positive on stocks over bonds, but sentiment may be getting a little hot right now so we wouldn’t be surprised to see volatility pick-up,” noted LPL Chief Market Strategist Ryan Detrick. “Bond yields are also a bit stretched, so we may see them retrace a bit if stocks pull back.”

February’s Fixed Income Results

The bellwether Bloomberg Barclays US Aggregate Index finished the month lower, while its yield increased. The 10-year Treasury traded in lockstep with the US Aggregate. Most major US bond sectors finished the month lower. Corporate high yield, as denoted by the Bloomberg Barclays High Yield indexwas a bright spot in Februaryincreasing marginally for the month.

International bonds, denoted by the FTSE World Government Bond Index, and emerging markets debt, measured by the JP Morgan Emerging Markets Bond Index (EMBI), ended the month lower, while their yields rose.

Bond yields are rising in anticipation of improved economic activity. For more of our thoughts concerning fixed income, please read our blog post titled Treasury Yields Are Rising. Now What?

Oil and Natural Gas Fuel Higher

West Texas Intermediate crude oil (WTI) climbed above $60 this month. There are many reasons for this commodity’s recent rise.

  • Historically cold weather in Texas has limited overall US production by approximately one-third.
  • Global demand from India and China are quickly improving, while OPEC production cuts from last year are still in play.

Recently, LPL Research has grown more optimistic on both crude oil and the energy sector, based upon both fundamental and price trends.

Silver Sparkles

Silver had a solid month, returning over 5%. In addition, copper is up over 12% for February.  The industrial metals have enjoyed a strong run this year reflecting China’s strong economic prospects along with improving conditions in the United States. In addition, strong price momentum favor the industrial metals. LPL Research has recently upgraded its view of the industrial metals for these reasons.

US Economic Data Recap

Conference Board’s Leading Economic Index (LEI). The Conference Board’s Leading Economic Index (LEI) increased 0.5% month over month in January. This follows a 0.4% increase in December along with a 0.9% increase in November. The growth in the January LEI accelerated slightly from December’s LEI, which had fallen to its slowest pace in six months prior. The Conference Board noted that January’s gains in the LEI were broad-based among their indicators. This may suggest that the economy will improve over the first half of this year.

Inflation.  Inflationary pressure again remained tame in January, with the core Consumer Price Index coming in flat compared to December. January’s core Consumer Price Index increased 1.4% year over year.

January’s producer prices, measured by the core Producer Price Index (PPI), increased the most since December 2009. The PPI for final demand of finished goods increased over 1% last month.  Year over year, the January PPI increased over 1.5%. Inflation has risen slowly from low levels, but may still reach the Federal Reserve’s (Fed) inflation target in 2021.

US Consumer.  The Conference Board’s Consumer Confidence Index increased in February from January’s reading. This was the second uptick in consumer confidence after two straight months of pullbacks. Nevertheless, it currently remains well below the pre-COVID-19 report from February 2020. The Present Situations Index increased after declining in January, reflecting the near-term impact of the surge in COVID-19 cases.

The University of Michigan consumer sentiment survey for February reached a six month low. Sentiment slipped compared to January as Americans were a bit downbeat concerning the economy as well as the future business climate. The sentiment measure, which came in at over 76, is down over 25 points from levels reached a year ago.

Retail Sales.  Following a weak December, January retail sales increased over 5% month over month. This was well ahead of the over 1% expectations. Every major category of spending saw gains.

US Home Sales.  Sales of previously owned US homes increased again last month, reaching their highest level since 2006 according to the National Association of Realtors, given still low interest rates. Sales were up over 14% versus a year earlier. In addition, at the end of January, the inventory of homes for sale stood at just 1.04 million, the lowest inventory level since Realtors started collecting data in 1982.

Small Business Sentiment. The National Federation of Independent Business (NFIB) Small Business Optimism Index declined again in January, and sits below its 47-year average of 98. This is the second month in a row in which the index stands below its average reading. In addition, those surveyed who expected improved business conditions over the next six months declined to a level not seen since about eight years ago. As noted in the report, many small business owners in certain industries are still impeded by state and local COVID-19 restrictions.

Federal Reserve (Fed) News.  Federal Reserve Chairman Jerome Powell gave his semi-annual congressional testimony this month. Powell told the Senate Banking Committee that both inflation and employment remain well below the Fed’s goals. Given this, the Fed is likely to maintain its current monetary policy. Powell also stated that price pressures remain mostly muted and further commented that the economic outlook is “highly uncertain.”

Fed Chairman Powell noted that since the genesis of COVID-19 last spring, consumer prices partially rebounded over last year. However, pricing still remains soft in sectors most adversely affected by the pandemic. Fed policy is most likely going to depend on COVID-19 mitigation efforts in addition to how quickly the employment picture improves across all sectors, but especially the service sector.

Chairman Powell stated that the real unemployment rate in the United States is closer to 10% due to misclassification errors being factored into the official government statistics along with individuals dropping out of the labor force. The Bureau of Labor Statistics recently reported the unemployment rate at 6.3%.

US Employment. The US unemployment rate has declined, but is still a ways from full employment levels. COVID-19 continues to play an adverse role on service industry employment in particular. Even though the unemployment rate has declined from a peak of approximately 15%, we still have more room to make up before having an economy at full employment. The distribution of COVID-19 vaccines along with spread mitigation should help the employment landscape.

Looking Ahead

As the Fed has indicated, market participants will be keeping a close eye on progress with vaccination programs as well as changes in COVID-19 cases. Strong fourth quarter earnings was an important driver in this year’s market results so far, but this trend needs to continue in order for equities to perform well. How we manage COVID-19 in the wake of ramped-up vaccine production and distribution could also have a major influence on the investment landscape for the rest of 2021.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results. All market and index data comes from FactSet and MarketWatch.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

U.S. Treasuries may be considered “safe haven” investments but do carry some degree of risk including interest rate, credit, and market risk. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

For a list of descriptions of the indexes referenced in this publication, please visit our website at lplresearch.com/definitions.

This Research material was prepared by LPL Financial LLC.

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