January 2021 Monthly Market Review
The optimism that drove markets in December waned in the first month of the new year. In the first full week of January, the joint session of Congress to certify the results of the electoral college—typically a ceremonial process—was marred by violent protests and riots. Undeterred, Congress reconvened after rioters were cleared from the Capitol and affirmed Joe Biden’s election as president in the early hours of the next morning. Despite certification of Biden’s election and Democrats winning control of the Senate following the runoff elections in Georgia, the political climate remained tense and divisive.
Select areas of the market delivered positive returns. One of the more surprising developments was the disruption caused by followers of Reddit’s “wallstreetbets” forum—self-described as “like 4chan found a Bloomberg terminal”—which impacted small cap equity performance and caused many hedge funds to change their exposures.
In addition to these unprecedented events, the COVID-19 pandemic continued to influence markets as the prospect for more deficit spending increased with a Democrat-controlled government, which impacted inflation, rate markets, and commodity prices.
Small caps continued their upward march, with the Russell 2000 Index’s 5% gain handily outperforming the 1.0% decline of the S&P 500. The risk-on environment for small caps reached a fever pitch as stocks with the highest short interest posted the largest gains.
Initiated on Reddit and inflamed on Twitter, the short squeeze phenomenon was highlighted by video game retailer GameStop, which gained over 1,600% for the month. By itself, the stock contributed 64 bps to the Russell 2000 Index performance and became its second largest component by month-end, before selling off sharply in early February.
With the gains from GameStop and other heavily shorted names, such as retailer Bed Bath & Beyond (+98.9%), consumer discretionary (+14.6%) was the Index’s top performing sector. Energy (+14.0%) followed shortly behind, building on its momentum from late 2020. Materials (−2.8%) was the worst performing sector, dragged down by concerns about the aluminum market; aluminum companies Alcoa (−21.9%) and Arconic (−15.4%) were notable detractors.
There was wide dispersion among hedge funds in January. Goldman Sachs “Highest Short Interest” basket, which includes the 50 stocks in the Russell 3000 Index with market capitalizations greater than $1 billion that have the highest percentage of short interest (as measured by float) gained 42.4% for the month. By contrast, the Goldman Sachs “VIP” basket, which includes the 50 stocks that appear most frequently as top 10 holdings of hedge funds, declined 1.9%.
Hedge funds “degrossed” as a result of heightened volatility and the short squeeze. Prime brokerage groups from major banks reported significant reductions in hedge fund gross exposure in the final week of the month. Goldman Sachs’ prime brokerage group reported that January was one of the worst months on record for long/short alpha generation due largely to negative returns from short books.
The dynamics in U.S. equities and hedge funds overshadowed the strong performance for the month by emerging markets (EM) equities, which gained 3.1% (USD) and outperformed their developed markets counterparts. Performance dispersion was wide across geographies.
China (+7.4%) was among the top performing countries, driven by a shift in sentiment following livestreaming platform Kuaishou’s announcement that it plans to raise up to $6.3 billion in a Hong Kong IPO in early-February. This marks the largest tech IPO since Uber Technologies in 2019 and helped boost the tech and communication services sectors overall. Tencent (+20.8%), which owns an estimated 21% stake in Kuaishou, rallied on the news and was the single largest contributor to broad market performance.
On the opposite end of the spectrum, countries such as India (−2.3%) and Brazil (−7.8%) finished in negative territory and weighed on returns as they continued to grapple with economic reopening amidst a spike in new COVID-19 variants.
EM assets recorded $17 billion in inflows within the first three weeks of the year, largely into equities. This follows a strong year in which emerging markets recorded $360 billion in inflows from the pandemic low in March through December. Investor sentiment surrounding the asset class is largely centered around better than expected performance of many EM countries amidst the pandemic, optimism surrounding the vaccines, and hopes that export-oriented countries will benefit from an increase in demand from China and an increase in U.S. infrastructure spending under the Biden administration.
Following the inauguration, the Biden administration announced a $1.9 trillion stimulus plan. While Republican resistance was strong given that a $900 billion stimulus plan was passed in late December 2020, forward inflation rates reflect a view that the combination of additional fiscal stimulus, ongoing monetary policy support, and the vaccine rollout will be positive forces for the economy.
Widening breakeven inflation expectations occurred through a combination of falling real yields on U.S. TIPS and rising nominal yields on U.S. Treasuries. Long-term U.S. Treasuries fell 3.6% and U.S. TIPS rose 0.3% for the month.
Real asset categories reacted favorably to rising inflation expectations. Commodities rallied 4.9%, led by gains in the agriculture/livestock category (+4.8%) as well as in crude oil (+7.6%), which finished the month at $55/barrel. The recovery from $10/barrel oil in April 2020 was dramatic and well ahead of many forecasts. Gains in January were also driven by stimulus and vaccine distribution, which are expected to spur a further recovery in demand. These advances were supported by the decision of the Organization of the Petroleum Exporting Countries support to extend existing production cuts and Saudi Arbia’s surprise unilateral production cut of 1 million barrels per day to help balance the market while vaccines are deployed.
Midstream energy equites (+5.8%) and resource equities (+1.3%) continued to benefit from the rise in commodity prices and improving fundamentals, after finishing up 32.4% and 18.9% in the fourth quarter of 2020. However, gains were pared later in the month after a series of climate and energy policy-related executive actions by Biden signaled greater scrutiny and potential headwinds for the sector. These include a 60-day suspension of new oil and gas leases on federal lands (existing federal leases account for approximately 9% of total production) and the cancelation of the controversial Keystone XL pipeline project. Policies that support energy demand, such as stimulus, but restrict production or increase costs are potentially bullish for commodity prices.
Elsewhere, clean energy stocks continued to move higher (+6.3%) after rallying 52.4% in the fourth quarter of 2020. Valuations pushed higher due to accelerating growth and expectations that the Biden administration and Democrat-controlled Congress will provide additional policy tailwinds. The universe of pure-play clean energy stocks is growing, but remains narrow. Meteoric gains in the sector have been driven in part by tech-oriented names as opposed to renewable production companies and renewable oriented utilities, including Plug Power, which advanced 1,094% during 2020 and 86% in January alone.