The equity markets started off the new year strong, continuing the post-election rally carried over from 2020. However, the month ended on a down note, giving back all the gains from earlier in the month and then some. Large cap growth started the year on weak footing, while large cap value continued the lead. Ultimately, however, the forces of the market turned most areas in the large cap space downward, each ending the month with similar losses. Small and mid-caps fared better, but also faded during the last week of the month.
For January, the S&P 500 closed lower by 1.1% and the bond index lower by .7%. The Small cap Russell 2000 index stayed positive, posting a 5% gain for the month after ascending to a 10% gain to start the year that also faded into the month’s close. Energy, health care and real estate are the top-performing sectors YTD, while the materials, industrials and consumer staples sectors are down the most.
MARKET DRIVERS
For the first half of the month, we observed a continuation of what worked in the last months of 2020 – small caps and value outpacing large caps and growth. However, during the third week, we observed a rotation where large cap tech once again took the lead and outpaced the broad market. This, to us, could be due to mega cap tech having lagged the broader market for most of the fourth quarter, or the market getting a little nervous of the post-holiday spike in COVID cases, a disappointing rate of vaccination, and whether the Biden administration could pass the fiscal measures it announced in early January. To us, it seemed, the market may be seeking the perceived safety of mega cap tech as we moved into an environment clouded with near term uncertainty. For the final week of the month, the market sold off and erased the broad markets gains for the month.
Part of the volatility was possibly brought on by the sideshow surrounding heavily shorted names, such as Gamestop and AMC Cinemas. Not to get too technical, but this anomaly and strange market activity in these, and other names, perhaps caused a liquidity crunch that forced the hands of some big market participants to sell highly liquid, large cap names to raise cash to offset volatility from other, smaller holdings. We hope this distraction passes, and the market can get back to trading on fundamentals, which continue to show improvement.
As earnings season was in full force, over 75% of companies reported earnings that beat expectations, and signaled positive guidance for the year ahead. This is in stark contrast to last year, where most companies’ outlook was very cloudy, due to the unknown impact of the then-new COVID pandemic, as many companies simply omitted earnings guidance. This quarter’s reporting, however, suggested that corporate America sees the light at the end of the tunnel, and expects economic activity to pick up significantly as the world moves farther away from the worst effects of the pandemic.
PORTFOLIO ADJUSTMENTS
In light of the observed pricing action, we were quite busy shifting some exposure in our model portfolios as we sought to increase exposure to trends that could be durable, but the month proved tricky.
Early in the month, given the ongoing “broadening” of the market, we shifted our long time holding, QQQ, to its equal weight counterpart QQQE, similar to what we did with the S&P 500 fund, SPY, the month prior. However, after the middle of the month volatility, and perceived shift back to mega cap tech, holding QQQE was short lived and we rotated back to QQQ, which has outpaced QQQE ever since. We also removed our small cap blend position (IJR) and captured a healthy 10% profit in a little over a month of holding small caps. We ultimately came back to IJR towards the end of the month as small caps held up better during the market’s month end decline. We also shifted some money from the S&P top 50 (XLG) to QUAL, which is less dependent on the FAANG complex, but still invests in mega cap names with healthy balance sheets and broader exposure beyond tech. Finally, we began to layer in a position in The Ark Innovation fund (ARKK), a mid-cap growth fund that invests in companies that are considered “disruptors”, such as Tesla, Roku, Square, Teledoc, Spotify, CRISPR Therapeutics and Zillow Group industries. This position adds some beta to the portfolios, and we feel that industry disruption, which began in earnest last year, can continue.
LOOKING AHEAD
We remain optimistic that the financial markets can continue to heal from the wounds inflicted from 2020. Hospitalization and death rates have cratered in recent weeks (25% reduction of the weekly average), and a coordinated effort to get more people vaccinated will reduce the overall spread of COVID, perhaps rapidly. That elusive light continues to shine brighter, combined with the anticipation of some form of fiscal stimulus, as well as the Fed’s commitment to keep rates low, provides a supportive backdrop for higher prices ahead, at least for the first half of the year.
We hope you all are staying warm during the cold winter months, as well as maintaining your ongoing commitment to a socially distant lifestyle – we are likely in the final innings of this pandemic and all of us here at TWG want you to get through the months ahead safe and healthy.
