– March 2021
“Spring is sprung, the grass is ris. I wonder where the birdies is. They say the birds is on the wing. Ain’t that absurd? I always thought the wing was on the bird.” – Anonymous
Happy spring. We hope this finds you safe, well and enjoying the warmer weather. As we work our way through March, things are springing up in the capital markets, and we at Atlas are working to stay ahead of them for you.
As many of you have noticed, the financial news lately has been citing the recent rise in interest rates, particularly on the longer end of the yield curve. For some context on how much rates have changed, I’ll start by going back about 7 months to the early part of August last year. At that time, the 10-year U.S. Treasury Bond (often used as a benchmark for interest rates in the U.S.) was yielding a mere 0.52%. By year-end, the rate had come close to doubling, ending 2020 at a yield of 0.93%. Since the beginning of this year, the 10-year rate has risen to 1.66% (as of the time of this writing). A move of a little over 1% may not seem remarkable at first blush. Viewed another way however, the fact that the yield has more than tripled in the last 7 months can be seen, in fact, as extraordinary. To be sure, a rate of 1.66% on a 10 year bond isn’t going to do much to generate income for those seeking to do so. But, as an economic “canary in the coal mine”, it may be quite meaningful. By watching benchmark rates, we can “listen” to what the markets might be telling us about these things.
This ability to “listen” to the markets assumes an understanding of what drives certain indicators. As we know, pure interest rates (such as U.S. Treasury Rates) are driven by two factors: economic growth expectations, and expectations for the rate of inflation.
ECONOMIC GROWTH – There are two ways to increase the economy’s output;
One is to add more productive workers. Notwithstanding, the interruption to employment trends resulting from the pandemic, employment rates have been high, leaving few unemployed productive workers to add to the economy. In addition, birth rates over the last couple decades do not lead us to anticipate a meaningful enough uptick in new workers entering the labor force to fuel above-average growth.
The second way to expand output is to increase worker productivity. This can be done with things such as technology, training, or increased worker hours to name a few. Unfortunately, productivity gains that were so strong during the beginning of the technology boom have been waning in recent years. So, unless a real turnaround is on the horizon (which doesn’t appear to be the case), it will be difficult to make the argument in support of imminent increases in productivity.
As I’ve pointed out in earlier articles, our expectations at Atlas are for economic growth over the next 10 – 15 years to be below that of the post WWII expansion up to about 2010. In the next two years however, we could see strong economic growth as we rebound from the effects of 2020.
INFLATION – We know that a popular definition of inflation is too much money chasing too few goods and services. In the current environment, we can see that through government stimulus and relief programs related to the pandemic, there is a lot of cash out there to be used. While prices for building materials and manufactured goods are clearly rising, there may be offsetting factors in the service economy, and companies there may take much longer to recover pricing power.
Overall, there is unused capacity in both the manufacturing and service sectors of the economy. As a result, we think that the jury is still very much out on overall inflation.
With all of that in mind, we expect a strong economic rebound from 2020 to fuel above-average economic growth for the coming two years. If inflation concerns do pan out, the result could be higher interest rates in the intermediate future. Still, we would expect that the secular trends of the economy will prevail sometime in the coming five years, and things will stabilize in that time.
As rates rise, we expect that the trends that have been in place in the markets for about 10 years, may change. Specifically, we believe that the growth strategy may yield to the value style of investing to some degree. We have recently seen some “high flying” growth stocks come back a bit as investors begin to understand that as borrowing costs rise, growth may be more difficult to obtain for companies. Thus, the price paid for a stock may begin to be more of a factor than a company’s growth projections. In addition, as rates rise, we would expect to see improvement in certain sectors that would benefit from a higher rate environment. Certain stock sectors that have languished for some years may be in the early stages of a recovery. Further, we have witnessed a recovery in small and mid-cap indices. Fortunately, we have maintained a solid allocation to those categories, and that has proved beneficial for our clients.
In essence, we are witnessing a rotation in the markets that is presenting an opportunity for us to reallocate some portions of portfolios to prepare for the coming years. We are and will continue to evaluate these market changes, and adjust portfolios accordingly.
If you have questions about this or any other matter, please feel free to contact your Atlas Wealth Management Advisor.
 “U.S. Department of the Treasury- Daily Yield Curve Rates.” Daily Treasury Yield Curve Rates, 17 Mar. 2021, www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yieldYear&year=2020.