Gill Capital Partners January 2021 Update
Oh my! For those of us who were looking to put last year behind us, 2021 has picked right up where 2020 left off. We are only a week and a half into the year and already we have seen riots, protests, impeachment talks, a blue wave surprise, higher interest rates and big tech getting serious about censorship. We will touch on all of these, but first a bit of humor.
Deonte Gordon on the January 6th U.S. Capital riot:
“Well played December 37th, 2020. Well played.”
Election Update
The two Democratic candidates unexpectedly swept the Georgia U.S. Senate races last week, giving Democrats a narrow majority in the Senate. Democrats now have a majority in both chambers of Congress as well as control of the White House. This was a result that many feared would send markets tumbling lower, but, for now at least, the opposite has happened, with markets reaching new all-time highs following the election results.
Our view – Why did markets move higher in response to the surprise Democratic sweep of Congress? This will likely mean higher taxes and new regulation; the anti-growth redistributionists will take over and this will be bad for the economy, right? Not necessarily. For the most part, the markets loved what happened in Georgia, likely for a few reasons. First, the market absolutely despises uncertainty. The Georgia runoff elections kept buyers away from the market, as many investors opted for a wait and see approach. Second, higher taxes was the real fear if the Democrats gained control, right? The reality is that there is not much of an appetite in Congress for higher taxes on either side of the aisle. This, combined with a razor thin margin in the Senate, means that the market views materially higher taxes as an unlikely outcome. Further, the market views any potential tax reform to likely include a change to state and local tax deductibility, which may help offset any potential tax increase. Third, the market believes that with a Democratic majority, there is a greater likelihood of another, and perhaps more significant, stimulus package, along with a major infrastructure bill. The market sees both as very positive for economic growth.
How do the election results impact different economic sectors and what stocks may benefit/suffer as a result?
Retailers – Retailers such as Target, Bed Bath and Beyond, and Dollar General have benefited since the election as these names are likely direct recipients of stimulus dollars, and with more likely on the way, they are moving higher.
Financials – Interest rates have been moving higher (we will discuss more below), and this is fabulous news for the beaten up and unloved financial sector, where higher rates mean better margins on loans. Money center banks like JPMorgan and Wells Fargo have been moving higher.
Energy – Unloved and left for dead, the energy sector is finally showing signs of life, with oil prices rebounding on the prospect of an economic reopening at some point in the future. Energy stocks have been moving sharply higher over the past few weeks.
Technology – Is big tech in big trouble? With the about face on censorship by big tech over the past few days, this one is a bit more complicated. Yes, with the Democrats in control, big tech will face the possibility of increased regulation and possible antitrust issues. However, many Democrats in the Senate recognize the benefit big tech offers, as these businesses employ and provide important services for many of their constituents. We feel they are only likely to take things so far, as they will not be overly excited to “bite the hand the feeds them.” However, the events of the past week have yielded a new dynamic where big tech companies, perhaps sensing an imminent change of sentiment towards liability protection following the riots last week, have taken a hard line against riotous language, conspiracy theories and “fake news.”
Big names like Amazon, Facebook, Twitter, and Google have not participated in the recent rally of the past couple of months; in fact, many are down or flat over the past six months. The “old playbook” says sell these growth stocks and buy value stocks (financials, energy, industrials) when rates begin to rise and economic growth begins to rebound. However, there is still a strong case for owning technology, as this is where growth and innovation happen in our economy. Growth stocks may take a pause for a bit, but certainly in the long term they are “surfing in rising waters,” as they say, and will continue to be the growth engine of the economy.
Rising Rates – Intermediate and long-dated interest rates are moving higher in rapid fashion following the election for the reasons mentioned above. The market is betting on more government spending, which will drive growth. The market also believes that widespread availability of a vaccine will lead to a reopening of the economy, which will likely bring higher inflation and growth. Short term rates, which are largely controlled by the Federal Reserve, are still pinned down at historically low levels, but longer dated interest rates are on the move. The interest rate on the 10-year U.S. Treasury, for example, now sits at roughly 1.17%, up from 0.50% in July of 2020.
Our view – While 1.17% may not grab your attention, that is a 100% increase in interest rates in a very short period of time. Remember, interest rates and bond prices move inversely to one another, and the more time your bond has left until maturity, the more sensitive it is to interest rate movements. For this reason, we have generally maintained short maturities within our portfolios, as value can erode quickly in a rising rate environment, and this gives us the flexibility to reinvest maturing proceeds at higher rates. Higher rates do not just impact bonds; nearly every investment’s value is tied in some way to interest rates. Stocks, for example, benefit from low interest rates, as businesses can borrow capital at low rates. Furthermore, low interest rates incentivize investors to move out of unattractive fixed income investments and into those that provide better growth opportunities, such as stocks. Higher interest rates can also slow the broader economy, acting as a broad-based headwind for equities if interest rates are restrictive to the overall economic environment. However, at the current low levels, it is a reach to say that interest rates will be a hinderance to growth or borrowing in the near term. Furthermore, the Federal Reserve will maintain their accommodative stance and has made it clear that they are not looking to increase interest rates any time soon. All of that said, we do not see rising interest rates at their current level as being prohibitive to economic growth. However, rapidly rising rates can spook markets temporarily, and we would not be surprised to see that play out again in the near term if the recent trend continues.
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.