Weekly Overview
• Headlines involving heavily shorted stocks, chiefly GameStop, caused hedge funds to reduce their equity exposures at the fastest pace in over six years, resulting in heavy losses.
• Fed Chairman Jerome Powell struck a very dovish tone in his statements last week, reaffirming the Fed’s commitment to remain accommodative, even after the economy is fully reopened. He also laid out the Fed’s expected timeline for tapering asset purchases, which extends well beyond recent expectations, and downplayed concerns.
• Economic data improved, including week-over-week gains in both initial and continuing jobless claims of 847,000 and 4.8 million, respectively. Residential construction increased nearly 14% in fourth quarter of 2020, while new durable goods orders rose 0.2% in December alone.
Market Drivers And Risks:
• Individual investors flex their muscles. In a dramatic shift, last week’s volatility was not driven by coronavirus- or stimulus-related headlines, but rather by a history-making short-squeeze coordinated by a pool of individual investors leveraging social media and online chat groups. Short sellers of GameStop lost over $5 billion year to-date through January 27, as a group of individual investors relentlessly bid up its stock.
• Much has been made of this story, from a "David vs. Goliath" narrative to questioning the role of regulators. But we see a more significant takeaway: Individual investors with growing access to capital and markets are a force to be reckoned with. Indeed, the way we view equity market investing may have just structurally changed, permanently. Fundamentals will continue to drive markets over the long-term, but collective groups of individual investors are now moving the money, rather than simply chasing it.
• Economic recovery hopes receive a booster shot. Concerns over growing coronavirus case numbers, hospitalizations and deaths, paired with a disappointingly slow public rollout of vaccines, have left investors skittish and led to pockets of volatility. Thankfully, we have gained traction with positive efficacy rates of two new vaccination candidates, as well as improvements in coronavirus-related data. As it becomes more likely that the coronavirus environment may linger longer than expected, such data represents the tangible evidence markets need to feel more confident about an eventual full economic reopening. As a result, we maintain our modest risk-on positioning, looking to quality cyclicals and small cap stocks to continue their recovery.
• Earnings are being overshadowed. An impressive start to earnings season was largely overlooked last week, given short-selling activity. Apple, Microsoft, Tesla and Facebook all had positive reports. We continue to expect earnings to drive market appreciation in 2021, especially through the remaining three quarters, but we are off to solid start.
Risks To Our Outlook
The pace of vaccine distribution appears to be accelerating, and a recent executive order pledging 100 million doses in 100 days should help alleviate concerns. But new and emerging coronavirus variants could lead to lower efficacy rates of existing vaccines, potentially leading to deceleration in economic growth and negatively impacting our modest risk on positioning. Additionally, stimulus-driven volatility is likely to persist in the near-term as Congress works toward passing the proposed $1.9 billion package. The next few months could remain challenging for investors, and continued high volatility and possible near-term market selloffs are likely. Last week’s trading bucked the recent trend of resiliency in stock prices, with the Volatility Index (VIX) eclipsing the 30 mark for the first time since November.
In Focus: Emerging Markets Poised For Leadership In 2021
• Despite stretched valuations and significant downside risks globally, we believe emerging markets (EM) equities should outperform their developed market counterparts in 2021, especially as the U.S. may struggle due to policy and valuation headwinds. The current state of global equities reminds us of the environment immediately following the Global Financial Crisis, when EM returned 79% in 2009 and 19% in 2010. While EM equities may not appear cheap in absolute terms, their valuations are more historically attractive than those of U.S. equities.
• The economic impact of the coronavirus crisis in China, Korea and Taiwan was milder than in other parts of the world. In fact, China is one of the few economies that grew in 2020. However, with multiple vaccines being rolled out, the coronavirus-recovery trade will likely come into greater focus in 2021. Even countries in the so-called “coronavirus-loser” category—such as India, Brazil, Mexico, Indonesia and Peru—have started performing well. We expect this to continue over the next six months. Latin America, dominated by Brazil and Mexico, could be among the top medium-term performers.
• Key tailwinds for EM going into 2021 include: attractive relative valuations, a weaker dollar, strong Chinese growth, an improving geopolitical outlook, a widening growth gap between EM and the U.S. and a shifting paradigm favoring EM over the U.S.
Saira Malik is chief investment officer at Nuveen.