Why Did the Market Drop and Why Did Interest Rates Go Up?
This week, the S&P 500 dropped 2.5%. The Dow Jones Industrial Average dropped 1.8% while the Nasdaq dropped 4.9%. Paradoxically, a positive outlook for the economy generated this week’s changes.
Dropping COVID infection numbers, positive vaccination updates, and the continued push by the Biden Administration for an additional stimulus package all reinforced the positive outlook. As investors feel optimistic about the future, they move out of bonds. The diminished demand for bonds drove bond prices down. The yield on a bond has an inverse relationship to the value of the bond. As the bond value drops, the bond yield increases. The increased interest rates add a burden on companies as they service their debt. That expected burden pushed down prices for equities. Rising interest rates and expected economic growth also trigger fears of monetary policy changes and inflation.
Oddly enough, as interest rates rise, some investors move out of stocks and back into bonds because of the increased return possibilities in bonds. That may explain why we saw a rate drop at the end of today after the initial rate climb.
Along with the positive outlook and expected economic growth, investors are shifting to equities that struggled last year and are expected to perform well this year. Since the big tech companies (like Amazon, Apple, Facebook, and Google) did so well last year, their upside potential seems less than other stocks. Therefore, several investors sold their tech shares at the beginning of the week and moved into other stocks. These big tech companies make up such a large percentage of the stock market, that they alone can drive the price of the major stock indices down.
We expect increased volatility in the stock market but the risk-reward outlook for stocks still makes them an attractive investment for 2021. Bonds have little reward with increased risk in the short term as rising interest rates remain a threat. We continue to find attractive opportunities in the private space, particularly in private lending, sellers of distressed assets, and green energy and wireless infrastructure.