By Mark Barnes, head of investment research (Americas), and Christine Haggerty, global investment research
Though the euphoria earlier this year has cooled with the dimming hopes for a V-shaped global economic recovery, equity markets have still marshalled periodic risk-on upsurges, most recently in late August.
In the US, these shifts in risk appetite have played out most vividly in the tug of war between small- and large-cap stocks, and well as between the industries that dominate each index: financials and technology, respectively.
Since badly lagging in Q1, the Russell 1000 has been on a steady winning streak, overtaking the Russell 2000 in July and then sprinting even higher until recently. For the year through August-end, the large-cap index amassed a four-percentage-point lead over the small-cap index (20.7% vs 15.8%, respectively). Large vs small-cap leadership has fluctuated mainly with shifts in global recovery expectations and long-dated US Treasury yields.
YTD 2021 returns ‒ Russell 1000 relative to Russell 2000 (TR, rebased)
Source: FTSE Russell. Data through August 31, 2021. Past performance is no guarantee to future results. Please see the end for important disclosures.
Reflation trade 2.0?
In its early stages, the reflation trade fueled robust rotations into cheap, small-cap and economically sensitive stocks most likely to get a lift from the strong reopening tailwinds and soaring commodity prices, notably financials, energy, basic materials and consumer discretionary. Large-cap growth-oriented stocks, notably technology, underperformed.
But as macro growth worries rose, the list of risk-on beneficiaries narrowed: Financials have tended to outperform during periods of rising long bond yields, given the positive implications for industry profitability. However, earlier rallies in energy and basic materials stocks have lost momentum with the recent retreat in commodity prices.
YTD 2021 returns ‒ R1000 and R2000 ICB Financials vs Technology (rebased)
Source: FTSE Russell. Data through September 7, 2021. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
As the industry return comparisons below show, Russell 1000’s performance edge this year has come predominately from strong gains in large-cap technology, financials and real estate and significantly smaller losses in health care. Technology dominates the Russell 1000’s industry exposures, with an overweight more than twice that of its small-cap counterpart.
The Russell 2000’s strength has also been concentrated in financials, as well as cyclically sensitive energy, basic materials and consumer discretionary stocks, which represent sizable overweights versus the large-cap index.
YTD 2021 ICB industry returns relative to Russell 1000 and Russell 2000 (% difference)
Source: FTSE Russell. Data as of August 31, 2021. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
August whiplash offers directional cues
Industry performances in August are illuminating. As the industry returns below show, financials in both indexes led gains for the month, as the uptick in long bond yields and modest steepening of the yield curve early in the month lifted the profit prospects for banks and insurers. Unlike in the Q1 risk rally, energy and basic materials stocks hugged the bottom of the performance list.
Tech stocks performed nearly as strongly as financials, but most of those gains came in the last two weeks of the month as waning recovery optimism weighed on long bond yields again and stirred greater appreciation for companies offering reliable earnings growth and healthy balance sheets.
August 2021 – Industry Classification Benchmark (ICB) total returns
Source: FTSE Russell. Data as of August 31, 2021. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Given lingering uncertainties overhanging the global health, policy and economic outlook, financial markets are likely to remain unsettled in the months ahead. Shifts among equity winners and losers and the macro prospects driving them hold important clues for negotiating the investment environment ahead.
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Originally Posted on September 20, 2021 – Financials and Tech Stocks Vie for Dominance in Risk-On/Risk-Off Battle
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