By Pete Biebel, Senior Vice PresidentPrint This Post
The focus of my article last week was the disparity in performance between the few leading groups and the rest of the market. While the market’s procession higher had slowed considerably in recent weeks, a few groups had continued to parade higher with many lagging sectors bringing up the rear. There also had been a disparity in performance between a relative handful of mega-cap stocks, which continued to march northward, and their smaller-cap bandmates.
Last week, the leaders of the parade reversed. Last week, the NASDAQ Composite Index (COMP) went backwards. COMP fell a little more than 1% for the week. Two previously leading sectors, Technology and Communication Services also turned south last week. They were the poorest performing of the eleven S&P industry sectors. Among the leaders last week were several of the sectors that had been just shuffling along at the back of the pack: Industrials, Basic Materials and Utilities. Both the S&P 500 Index (SPX) and the Dow Jones Industrial Average (DJIA) ended the week with small net gains. But while the cap-weighted SPX posted a 1.25% gain for the week, the equal-weight version had nearly triple that gain.
The market’s key development last week was a Monday/Tuesday flip-flop. A week ago I wrote, “One scenario that could play out this week that could be a cause for concern would be a slightly higher recovery high followed by a reversal. The June high was near 3233; a new high at say 3250 that is quickly reversed could be an early warning sign.” SPX and the other indices gapped higher on Monday’s opening. By midday, SPX touched a slightly higher recovery high just above 3235. But the averages dropped steeply that afternoon with the selling probably triggered by an announcement from California’s Governor shuttering bars, movie theaters, indoor dining and wineries statewide in response to a spike in COVID infections. SPX plummeted to 3150 before closing just above that level.
It was a classic signal for a potential reversal: a higher high followed by a steep sell-off with the averages closing with losses and near their lows of the session. If SPX had declined much further and had taken out the prior week’s low, the selling pressure would have probably accelerated. Instead, the averages did another about-face on Tuesday. The market did initially trade lower that morning but hit what turned out to be the lows of the day within the first half-hour. For the remainder of the session, stocks paraded higher. DJIA gained more than 2% on Tuesday while COMP was up less than half as much.
The averages launched higher Wednesday morning largely on earnings news from several big banks as well as promising news on a COVID vaccine. Both DJIA and SPX hit their highs for the week in the opening hour (about 3238 on SPX). Conversely, at its Wednesday high, COMP had barely retraced half of Monday’s loss. Apparently, the vaccine news was a positive for small-cap stocks. The Russell 2000 Index (RUT) gained nearly 3% in the opening hour on Wednesday. The averages failed to make any additional progress on Thursday and Friday.
Despite last week’s losses, Technology and Communication Services still have the best year-to-date performance of the U.S. equity sectors. Consumer Discretionary and Healthcare are the only other equity sectors with YTD gains. Two non-equity sectors lead all other sectors on a YTD basis: long-term Treasuries and physical gold.
The hopes for a COVID vaccine sooner rather than later have been the elixir that has enabled the market to be seemingly immune to the surprising increase in COVID infections. Whether that rate of increase in reported infections begins to level off soon is likely the key issue that will impact the market positively or negatively over the coming weeks. For the past couple months, free money from the Fed has emboldened traders to chase the stocks with strong upward momentum. Now many of those strong momentum names are beginning to stumble. While last week was the first sign of the stumbling, rallies in some of the lagging sectors saved the day. In the weeks ahead, we’ll be watching to see if sectors like Industrials and Basic Materials can continue to step lively and whether the mega-cap Tech stocks can reverse last week’s reversal.
The free money is still out there. The upward momentum of the leading stocks has lessened but is still strong. As I wrote last week, “The lack of performance for the majority of stocks suggests that the market may have reached the point where the Fed’s support has been offset by the growing threat of a slower than anticipated economic recovery. If the market is going to continue higher, it will need to see improved performance in the lagging sectors. The gains in the leaders have certainly been impressive, but many of them seem to be very richly valued at current prices.”
Last week, the leaders reversed their parade higher and the laggards were able to high-step forward. Higher recovery highs are easily within reach this week, but with the currently extended valuations, the averages are not likely to climb a lot higher. The market has pretty much already discounted a speedy economic recovery. We’ll continue to be on the lookout for another reversal from a slightly higher high, similar to last Monday’s action.
The procession of economic reports is unusually small this week, though it does include a trio of home sales statistics. Conversely, the earnings parade really picks up the pace this week. The list of earnings reports includes eight of the thirty DJIA components and more than seventy of the SPX companies. We can reasonably expect greater than normal volatility in those reporting stocks on the market openings through the week. In fact, based on the level of time premium in the near-term listed option contracts on several of those stocks, the market is projecting the potential for double-digit percentage swings in several of the reporting companies.
|Tuesday 7/21/2020||Chicago Fed National Activity Index, June||2.61|
|Wednesday 7/22/2020||FHFA House Price Index, May, M/M||+0.2%||+0.4%|
|Existing Home Sales, June, SAAR||3.910mm||4.795mm|
|Thursday 7/23/2020||Initial Jobless Claims||1,300K||1,350K|
|Leading Indicators, June, M/M||+2.8%||+2.6%|
|Friday 7/24/2020||PMI Composite Flash, July||46.8||50.3|
|New Home Sales, June, SAAR||676K||700K|
Links to previously published commentaries can be found at benjaminfedwards.com/For Our Clients/Educational Resources/Market.