2021 has been a strange year for the markets. It started off in the same way as much as 2020 ended with growth stocks soaring to new highs and much optimism about the vaccines and a return to normalcy. Since the market made its first high in February, much has changed, including a vicious correction for many growth stocks with many now giving back huge chunks of last year's gains.
But, if we take a step back and take a longer-term view, the market action could be construed in a different way. The first year of this bull market was phenomenal with a nearly 100% gain. The economic recovery has exceeded all initial expectations by a decent degree. Thus, the stock market is dealing with being overbought and excess bullish sentiment despite the fundamental factors still remaining supportive of higher prices such as earnings growth and low rates. Thus, the market has been resolving this tension by grinding higher and having sector rotations within the advance.
Regardless, it's been a challenging environment for investors and traders. Currently, economic growth is positive but decelerating, while inflation remains stubbornly high which means the Federal Reserve has pivoted to a more hawkish path. Given these constraints, it's not surprising that only a narrow band of stocks is currently advancing. Two sectors that investors should certainly watch are consumer staples, big-box retailers, and defense stocks. Exchange-traded funds focused on these stock sectors include iShares U.S. Consumer Staples ETF (NYSE: IYK), SPDR S&P Retail ETF (NYSE: XRT), and iShares U.S. Aerospace & Defense ETF (NYSE: ITA).
All of these groups' revenues are stable, and they won't be affected too much by slowing economic growth. They also provide protection against inflation as they have pricing power or see increased revenues when consumers are more focused on inflation. They also have large balance sheets and are able to take advantage of the decline in longer-term rates.
This also highlights another challenge - the narrowing yield curve. Over the last few months, we've seen short-term rates rise, while longer-term rates decline. From mid-August, the 2-Year Treasury yield has gone from 0.17% to 0.67%, while the 30Y has declined from 2.1% to 1.8%. A narrowing yield curve indicates less optimism about the economic outlook, while a steepening yield curve indicates the opposite.
Given this unique set of challenges, traders should focus on consumer staples, big-box retailers, and defense stocks as these stocks are not adversely affected by these factors.