The ETF Portfolio Strategist: 3 March 2021

Trend Watch

In this issue:

  • Reflation trade continues to pound Treasuries

  • Will the small-cap edge persist?

  • Value stocks are trying for a comeback

Treasuries take a new dive down: For a brief, shining moment it appeared that the rout in US government bonds had run its course. But today’s resumption of the long-running slide suggests otherwise. The benchmark 10-year Treasury yield ticked higher today (Mar. 3), rising for the first time in four days. Judging by the trend’s persistence, the reflation trade still looks destined to weigh on iShares 7-10 Year Treasury Bond ETF (IEF) for the near term. Helping to drive yields higher (and Treasury prices lower): rising inflation expectations, which are now at the highest level since 2008, based on the yield spread for the nominal 5-year Treasury less its inflation-indexed counterpart.

A good year so far for small caps: US equities of the small-cap variety are having a good 2021. Starting late last year, iShares Russell 2000 (IWM), a small-cap proxy, is outperforming its large cap brethren (IWB) year to date: 11.9% vs. 2.1% through today’s close (Mar. 3). Micro-cap stocks (IWC) are doing even better with red-hot 23.4% gain so far in 2021.

Can it last? It’s a reasonable question since small caps periodically outperform, but not for long, or so the past decade or so tell us. Is this time different? If there’s a reason for thinking so, maybe it’s the sharp turnaround of late. The chart below shows the ratio of IWM to IWB. The dramatic rebound this year in the ratio (an indication of small-cap outperformance) stands out from the usual shifts. It remains to be seen if this is an early sign of an extended run of small- and micro-cap outperformance, but it’s certainly on the short list for thinking why 2021 could be a turning point.

A turning point for value stocks? The long fade of value stocks in recent years has raised doubts about the viability of this risk premium, but there are signs of life stirring in what many have called the corpse of a once-great investing strategy. Perhaps, but it’s too soon to put a lot of confidence in the recent rebound of iShares Russell 1000 Value ETF (IWD) over its large-cap growth counterpart (IWF).

Yes, the pop is encouraging, at least by the diminished standards of value investing in recent years. But the bounce so far is mild and it’s not yet obvious that IWD’s recovery relative to IWF has staying power. We’ve been here before only to watch growth regain the upper hand. Fans of value investing, however, say that a strong tailwind is finally blowing for these stocks. That’s not obvious in the IWD:IWF ratio chart below (unless you squint). On the other hand, it’s not clear that value’s pop has run out of road. The second quarter is shaping up to be a critical test for the value-is-back narrative. But, hey, no pressure. ■