Reflation Nation

William Ehart

RAMPANT SPECULATION in parts of the market has been obvious for months. Less obvious is whether investors collectively will pay a substantial price for it. Can a reflation trade end up piercing a market bubble?

Stocks posted solid gains in February—with the S&P 500 touching a record high on Feb. 12—but the final week felt a bit precarious, even if the benchmark ended the month down just 3.5% from that high. (Insert your favorite adjective to describe the correction so far: normal, frequent, healthy, necessary.)

But some investors appear concerned that a sharp spike in Treasury yields may be changing the market calculus. The 10-year yield hit its highest level in a year at 1.51% on Feb. 25. That’s just a touch below the S&P 500’s 1.53% dividend yield. The S&P’s earnings yield—the inverse of the price-earnings ratio—is now at its lowest level in three years versus the 10-year Treasury yield. Those two points matter because higher bond yields now offer greater competition for investor dollars.

While the iShares Core S&P 500 ETF (symbol: IVV) gained 2.8% in February, energy, leisure and financial shares surged double-digits. The Vanguard Energy ETF (VDE) jumped more than 22%. Indeed, commodity prices are red hot. Copper is up 20% year to date and has nearly doubled since its March 2020 low. Gold, however, has been left out. The SPDR Gold Shares ETF (GLD) fell more than 6% last month.

Small- and mid-cap value gained strongly in February, followed by microcaps, despite a sharp pullback for the latter in the final week. The iShares Micro-Cap ETF (IWC), up 65% over 12 months, gained more than 6% in February, even after factoring in a nearly 5% drop in the last week. The Vanguard Small-Cap Growth ETF (VBK) also fell 5%. Large-cap growth lagged value again, with the Vanguard Growth ETF gaining less than a percentage point last month. It’s now negative for the year, while the S&P is up 1.7%.

Last month, developed foreign country stocks nearly kept pace with the S&P 500, while emerging markets trailed. The Vanguard FTSE Emerging Markets ETF (VWO), up 32% for the past year, rose 1.6% for the month, restrained by the formerly hot Chinese market, which fell fractionally in February. The iShares MSCI China ETF (MCHI), up 42% over the past 12 months, dropped nearly 9% in February’s final week.

Fuel for the fire? The pandemic—fewer trips, fewer meals out and free stimulus cash from the federal government—has helped goose the personal savings rate, which measures savings as a percentage of disposable income. Though well off its May 2020 high, January’s 20.5% rate remains far above earlier levels based on data going back to 1959, according to the Commerce Department’s Bureau of Economic Analysis.

Some are saying speculation in stocks like retailer GameStop and movie-theater operator AMC is driven by bored investors flush with stimulus money. GameStop, as of Feb. 19 down more than 88% from its January high, bounced nearly 170% over the five trading days that followed.

Though tame compared to AMC and GameStop, shares in the leisure sector have also been on a wild ride. Stocks of many companies in the movie, cruise line, hotel and theme park business have soared on the notion they’ll benefit from pent-up demand once people feel safe to travel and crowd into fun places. The Invesco Dynamic Leisure and Entertainment ETF (PEJ) gained nearly 16% for the month and is up almost 31% in the past three months.

Does all that money sloshing around—plus more on the way—put a floor under the market, at least for now? Or did investors “buy the rumor” of vaccine availability, stimulus and economic recovery, while preparing to “sell the fact”? Time will tell.

Where have all the houses gone? Mortgage rates had ticked up from a record low of 2.65% on Jan. 7 to 2.97% as of Feb. 25. Coupled with a modest supply of homes for sale, it’s no wonder the S&P/Case-Shiller home price index is at a record high and well above its previous peak in 2006.

One sign of Americans’ hunger to own their own home: The New York Times, citing Altos Research, reported on Feb. 26 that—compared to last winter—only about half as many homes are up for sale. Meanwhile, rents are falling and there’s a glut of empty apartments, the newspaper reported.

William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart and check out his earlier articles.

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