As we wrap up another wild month in the stock market, a look back at these headlines could provide some valuable insight for long-term investors. The S&P 500, Nasdaq, and Dow Jones each set new all-time highs in February before giving up some of their recent gains.
Meanwhile, the VIX volatility index dropped from its Jan. 2021 spike to reach the lowest level since the pandemic hit the US. It has since inched back up as investors try to balance the economic recovery, equity valuations, inflation concerns, and monetary policy expectations. Volatility is still a bit high as the index sits around 27, above the long-term average level. There are certainly risks present in today's market, but bulls continued to be rewarded in February.
Digging a bit beneath the surface reveals some important details about where we stand and where we might be going.
1. Corporate earnings were overall positive
Earnings season revealed promising signs of recovery for the largest U.S. companies, which should ease some fears that we're sitting atop a stock market bubble. According to Factset, more than 75% of S&P 500 companies reported higher-than-anticipated revenue and earnings in the fourth quarter. Those are some of the highest percentages in over a decade (Factset started compiling the data in 2008). Overall, the S&P 500 grew profits 3.2% year over year, reversing the consistent pattern of declines in the first three quarters of 2020.
Earnings guidance can offer some important insights into the state of the economic recovery, and here, the forecasts are a mixed bag. Despite generally encouraging performances in the fourth quarter, only 63% of S&P 500 companies that provided earnings guidance were positive. That suggests an overall favorable outlook, but uncertainty remains for this year.
2. The unemployment situation is worse than it looks at first glance
January's employment statistics painted a positive but uninspiring picture. The U.S. economy added 49,000 net new jobs, and the unemployment rate fell 0.4 percentage points. That was an improvement, but the country still has 10 million fewer people employed than it did before the pandemic. Moreover, only 6,000 of January's new jobs came from the private sector, and the workforce participation rate is nearly two percentage points lower than it was one year ago.
These statistics do not indicate that the country is in the midst of a rapid or broad recovery. A surge of economic activity might take hold in a few more months as the U.S. moves further away from this past winter's sharp spike in COVID-19 hospitalizations, but that still remains to be seen. A deeper look into the data also reveals an abnormally large percentage of people who have lost their jobs for a second or third time in the past year. Also, some industries and population demographics aren't sharing equally in the improvements, further underlining the tepid nature of recovery to date. The stock market will struggle to sustain its current valuation levels without broad-based support from improving business fundamentals.
3. Treasury yields are heading higher
The yields on 10-year Treasury notes have slowly risen, and they took a noteworthy jump in late February. Without getting too technical, this means that the prices of existing bonds are falling because investors are anticipating higher interest rates on bonds that will be issued in the near future. The market is sending signals on the rising likelihood that the Fed will taper its bond-buying activity -- a policy shift that could be triggered by positive economic news and rising concerns about the possibility of inflation.
Public remarks by the Federal Reserve's regional bank presidents have indicated no such change in policy is imminent, but the market has taken note of the relevant economic indicators tracked by monetary authorities. It obviously depends on a number of circumstances, but Fed tapering could send tremors through the stock market. This exact effect was on display in the "Taper Tantrum" of 2013 which occurred as the Fed moved to ease back from the historic quantitative easing it had initiated in response to the global financial crisis.
4. "There's no reason to be bearish"
Bank of America published its annual Global Fund Manager Survey, which collects sentiment and allocation data from a wide number of people who manage large sums of capital. Respondents were overwhelmingly bullish, and the overall share of their holdings allocated to cash was only 3.8%. That's the lowest level since the aforementioned Taper Tantrum, so there's not a lot of cash on the sidelines today.
The bank's executives have boldly claimed that there's no reason to be bearish right now, based on the assumptions that economic recovery will be rapid and monetary policy will remain accommodative. However, if those two assumptions don't bear out, there might actually be no reason to be bullish.
5. Meme stocks have lost their luster
The saga of r/wallstreetbets and Robinhood gripped the financial and mainstream media in January and February in a way that few stories do, but much of that fun appears to be in the rearview mirror. GameStop sits 79% below its January high, while AMC is down 61% from its peak. Numerous other "meme stocks" followed similar (if less pronounced) arcs.
Retail investors grew enraged after Robinhood and other popular brokerage platforms restricted trading on certain stocks, leading to speculation that corruption was creating an unfair market. In a completely predictable development, regulators announced that they were investigating the whole situation for market manipulation.
The fascinating mess ultimately didn't directly impact most investors, but it offers a valuable lesson: Strange and unexpected forces involving share supply and demand can warp aspects of the stock market in the short term. Over the long term, however, share prices are dictated by the fundamentals of underlying companies. We rarely see the contrast between speculation and investing drawn so clearly in major equity markets. Choose your side of the line wisely.