A much needed broadening out of this market rally hit a wall again, with mega cap leaders handily outpacing their cyclical brethren the past few days. Another new milestone was set on Wednesday for the Nasdaq. The tech heavy benchmark jumped over 2%, a strong move for just one day, but the number of declining stocks outpaced the number of advancers. This type of market action didn’t even happen during the tech bubble. We know those responsible. The FANGMAN group is so large they can move an entire market while most stocks are losing ground. That is not healthy action but has been typical this year.
Slowing the trend of money flowing back into cyclical sectors, namely banks, industrials, retailers and travel names, does not mean this reversion rally is over. It does bring some concern to the reopening trade though. We have plenty of excuses to bring back more caution. New Jersey Governor Murphy’s recent decision to allow schools to operate entirely remotely will be felt by parents who now need to stay at home and can’t afford extra care. Many school districts across the country are undergoing the same conversations.
Public schools are not ready to take on every student safely. Getting back to normal and more productive working hours is still quite difficult for families.
The Big Ten and Pac-12’s move to cancel college football takes away a lot of local spending as well. Estimates are in the billions of dollars when you add up sales for restaurants & bars, stadium employee salaries, concession sales, parking fees, tickets and booster spending. In some towns, college football is bigger than major holidays. To realize our full economic potential, schools must open but health concerns are first and foremost. If schools don’t have funding or clear plans to keep everyone safe, many parents will not want their kids attending class in person.
Obviously, anything that keeps people from going back to work is going to hurt the overall economy. The beneficiaries in such a scenario are the same winners in the stock market from the last few months. Online services, computer and cloud computing, network security, digital platforms and eat at home staples. This will last as long as the virus keeps us from getting back to a normal life.
“Normal” may look different in 2021+ but it will carry many of the same activities we’re accustomed to. People will want to watch movies at a big-screen theatre. Some of us are better cooks than before, but it doesn’t replace the restaurant atmosphere with friends, face-to-face. Vacations across the world are already being rebooked. Airlines will take time to get back to full capacity, but they will get there.
Brick & mortar shopping is back, especially internationally. Simon Property Group#, owner of the best mall locations, noted that outside the United States their malls are 100% open and showing 90% of 2019 sales volumes. The US market is only 91% open but back to 80% of typical sales levels. Some of this is pent-up demand and free stimulus but shows that people are eager to get out and mingle. In the future, there will be a balance between online and physical shopping. Retail stocks haven’t priced that in yet.
That is why the timing of vaccines or any therapeutic is so important for investors. The massive growth versus value stock outperformance eventually needs to unwind. A quicker roadmap to “normal” creates a funnel of investment flows into a new group of stocks. The Russian vaccine news, or more aptly put propaganda, added fuel to the rotation again this week. That is looking to be short-lived as we don’t see much follow through yet as banks, retailers and energy stocks lagged the technology leaders again.
One thing is clear, science will eventually win out. The billions of dollars thrown at research & development and thousands of talented professionals will make sure of that. We will adapt to changing lifestyles and will get better treatment options over the coming months. Industry pundits expect at least 1 vaccine in 2020, with several more to follow. Those in high-risk groups who want it, will get coverage first. It will take time to get to the masses. When that occurs, it should unlock the areas hardest hit from stay-at-home mandates. The stock market will sniff this out well before news headlines show a recovery in GDP.
Combine this with massive monetary stimulus measures across the globe and you could very well get new bull market leaders. This does not mean the FANGMAN trade is dead by any stretch. However, it would be quite normal for them to take a backseat as we revert back to normal. Valuations are stretched. The trading pattern looks very similar to the Y2K environment. Look at the graphic below. These stocks could drop by 25% and still be great investments for calendar 2020.
As Jim Meyer noted earlier this week, the shift has already started in some areas. The Dow Jones Transportation Average, filled with companies who ship goods across the globe, is up 20% in the past month alone bringing that index back to flat for the year. Many industrial and consumer discretionary stocks are showing similar upward moves. This is great action for diversified investors. It remains to be seen if banks and energy stocks can get their mojo back and rejoin the party.
Fixed income markets are getting in on the action as well. Though rates are astronomically low, a 45% move in 10-year Treasury yields over just one week to 0.72% caught many offsides. CPI and PPI data were well above estimates. The long-term inflation scenario is punk due to technology, excess production capabilities and competition, but it won’t take much to get fixed income yields back to pre-Covid levels. That is an opportunity and a risk.
Higher rates and inflation typically correspond with higher growth and better pricing power. A breakout in yields routinely goes hand-in-hand with a resurging economy. Economically sensitive stocks in cyclical and commodity industries thrive. However, the ultra-high P/E world would see a retraction in multiples. Discounted cash flow calculations with 0% interest rates relative to 3% interest rates spits out much lower terminal values.
We’d prefer a diversified market where all stocks go up, as opposed to a few high P/E leaders. Prudent investors are diversified and should remain so. Things are improving and could get real interesting once a true vaccine arrives. Timing is everything.
TV/movie stars Steve Martin, Halle Berry and Mila Kunis turn 75, 54 and 37, respectively today. Athletes Magic Johnson and Tim Tebow are now 61 and 33 years young.
James Vogt, 610-260-2214