There was no meltdown.
That’s the primary take-away from the first quarter of 2021. The pandemic is still with us but, unlike a year ago, investors are taking it in stride.
The numbers tell the story. The Dow is up 7.8 per cent in the quarter. The S&P 500 up 5.8 per cent. Nasdaq ahead 2.8 per cent. Here at home, the TSX gained 7.3 per cent.
It all looks pretty routine on the surface. Except it wasn’t. There were many unusual developments in the quarter that will almost certainly have ripple effects as the year progresses. Here are some key take-aways.
Central banks can only do so much
Both the Federal Reserve Board and the Bank of Canada are making cooing noises about keeping interest rates low. But the bond markets are paying little attention. The yields on 10-year U.S. Treasury bonds spiked sharply higher in the quarter, with Canadian bonds following along. The result was a steep decline in bond prices (when yields rise, prices fall).
Bond mutual funds and exchange-traded funds were hammered, leaving investors wondering where to put their fixed income allocations. Gold was another casualty, losing 9.5 per cent in the quarter as higher bond yields increased the opportunity costs of holding bullion, which pays no interest.
It appears the first-quarter trend will continue. That will mean more pressure on bond funds and gold, and for higher mortgage rates, which will negatively affect the housing market.
Tech stocks are not invincible
Technology stocks almost single-handedly saved the market from disaster in 2020. It’s been a different story this year. As noted, Nasdaq gained less than 3 per cent in the first quarter. The S&P 500 Information Technology Index was up only 1.7 per cent. The Dow Jones Internet Composite Index added just 2.7 per cent. Many high-profile tech stocks lost ground during the quarter, including Amazon.com Inc., Apple Inc. and Zoom Video Communications Inc.
There are signs that the tech sell-off is easing but based on first-quarter experience it is unlikely that the sector can carry the weight of the markets on its back through the rest of the year.
The energy sector isn’t dead
For a while there, it looked like the fossil fuels industry was dead. A year ago, they were literally giving away Canadian oil. Negative pricing didn’t last long, but it knocked the stuffing out of energy stocks. The S&P/TSX Capped Energy Index ended 2020 down 37.7 per cent.
It’s been a different story so far in 2021. The index is up about 32 per cent so far this year and has more than doubled since April 1, 2020. The oil price is back around US$60 a barrel, and the Organization of the Petroleum Exporting Countries and Russia feel confident enough in the global economic recovery to increase production levels. Energy stocks have responded accordingly. Canadian Natural Resources Ltd. gained 27 per cent in the quarter, while Suncor Energy Inc. was up about 23 per cent.
It would be unrealistic to expect gains of that magnitude to continue. But if the global economy doesn’t suffer another setback, the energy sector should continue to perform well for the rest of the year.
The mob can strike any time
The Reddit phenomenon was an eye-opener. It showed the world how a bunch of amateur investors could use social media to drive overlooked stocks to ridiculous levels. At the end of last year, you could buy a share of GameStop for US$18.84. The frenzied trading took it as high as US$483 in late January, with almost 200 million shares changing hands in a single day. Reddit followers cheered the pressure they put on Wall Street short sellers. Today, trading volume has tapered off and the price has pulled back to US$186.95 as of Monday’s close. But that’s still almost 900 per cent higher than the closing price on Dec. 31.
We’re not hearing much from the Reddit crowd these days. But they’re still out there, waiting to pounce. We haven’t seen the end of this story by any means.
Leveraging risks loom
According to The Wall Street Journal, the unravelling of Archegos Capital Management began with a March 25 phone call to merchant banks around the world, including Nomura Holdings, Credit Suisse, Morgan Stanley and Goldman Sachs. The fund was in financial distress and needed to liquidate US$30-billion in assets, the bankers were told.
It wasn’t just Archegos that had a problem. The banks were in trouble as well, thanks to a complex leveraging arrangement known as total return swaps. These involved the banks making investments on behalf of clients for a fee. The system had helped Archegos principal Bill Hwang to become a billionaire. Now it was blowing up in his face as Archegos and its banking partners were forced to liquidate huge blocks of stock at fire sale prices. The Journal estimates Mr. Hwang lost about US$8-billion in 10 days. Credit Suisse lost US$3-billion and the other banks lesser amounts.
Investors who own shares in the targeted companies became collateral damage. One of them was ViacomCBS Inc. Its shares plunged from more than US$100 to US$45 in five trading sessions. No one at the time knew what was happening. There was no announcement of bad news from the company. The stock just fell off a cliff for seemingly no reason.
We now know something of the extent of the shadowy manipulations involved. What we don’t know is how many other entities like Archegos are out there, exposing investors to risky leveraged positions. Best guess: too many. Don’t be surprised if more stories like this unfold as the year goes on.
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