This year has been a very strong year for both stocks and the economy, but that doesn’t mean there haven’t been some surprises. Below we take a look at some things that have happened so far in 2021 that have surprised the LPL Research team.
Surprise 1: Yields Aren’t Higher
Interest rates have surprised us twice this year. While we expected interest rates to increase this year, the strength of the move higher in the first quarter of 2021 was the first surprise. But reversing course and steadily falling since March may be an even bigger one. Put them together and the 10-year Treasury yield is still about 0.35% above where it was at the start of the year. Incredibly enough, we’re still in a rising rate environment. But the more recent decline is what’s on investors’ minds.
We don’t think there’s a simple explanation for why rates have fallen since March. A lot of factors have contributed: outsized inflation expectations coming down; short covering from crowded bets on higher rates; foreign buying; the drawdown of the Treasury General Account balance; and rising economic concerns about the impact of the Delta variant have all contributed. Part of the story is just one surprise correcting another. The 10-year yield had likely risen too far too fast in late 2020 and early 2021 and a course correction was natural, even if the pullback has been stronger than expected.
What’s the outlook for the rest of the year? Despite four months of falling rates, growth and inflation expectations still point to higher rates. Plus, don’t forget that the 10-year yield is still higher this year and we wouldn’t be at all surprised to see it resume its climb.
Surprise 2: Stocks Have Been Strong And Calm
Although we came into the year expecting solid stock gains, even we are surprised by just how much strength there has been this year for equities. After gaining 16% last year and 29% in 2019, the S&P 500 Index is up another more than 17% so far this year. Even more surprising though is the lack of volatility we’ve seen so far.
Historically, year two of a bull market can be choppy and quite frustrating. After the huge gains we saw the last nine months of 2020, we entered 2021 expecting there to be more give and take than we’ve seen this year. In fact, the S&P 500 hasn’t even had as much as a 5% pullback since October 2020, one of the longest streaks ever. That is very surprising indeed.
After more than a 90% rally off the March 2020 bear market bottom (and near double on a total return basis) we do think the odds are much higher of a standard 5-8% pullback during the historically troublesome August/September/October period. This isn’t a bad thing though, as some type of break could be necessary before another move higher.
Surprise 3: President Biden Has Been Tough On China
In the aftermath of President Biden’s victory, political pundits immediately began forecasting friendlier relations with China than had been experienced under the Trump administration. The logic was relatively straightforward. Foreign policy is one area where a president can act relatively unilaterally, and under the Obama administration, then-Vice President Biden played a crucial role in America’s policy of ‘engagement’ with China and reportedly had a warm personal relationship with President Xi Jinping.
So what happened? Since then, China has grown bolder in its ambitions to become the dominant global player, continuing unfair trade practices and intellectual property theft to help fuel its rise. President Biden seems determined to follow through on President Trump’s more hardline approach, maintaining the Trump tariffs on China, calling out China for human rights abuses, demanding a global investigation into the origins of Covid-19, and perhaps most importantly building a coalition of European allies to confront China on its trade practices and its increasingly aggressive foreign policy. Whereas President Trump took a more ‘on our own’ stance toward China, President Biden is building a coalition allied against China.
The more hardline approach may be particularly important during this period of significant technological infrastructure build out, such as 5G internet, which may set the technological rules of the road for decades to come. Frosty relations with China looks to be one feature of the prior U.S. administration that is here to stay.