Another rotation is underway as FANGMAN peaked early on Monday. That cohort has already declined about 5%+ this week, with profit taking in extended names taking hold. Netflix reported Q2 earnings yesterday, showing “only” 25% revenue growth and earnings per share that nearly tripled from last year. The stock is down 8% premarket. Their bull market is likely not over, but just like any other rally, nothing goes straight up. A simple decline in the mega-cap growth leaders back to their 50-day moving averages would bring the group down another 5%. It would also be quite normal to touch the 200-day averages which results in another 15% hit. None of this changes the long-term picture which is quite strong, valuation metrics aside.
The market can basically be grouped into three categories now. FANGMAN + stay-at-home leaders have attracted a lot of investment capital since the market lows. Likely too much. A consolidative, range-bound summer is warranted. The drops can be sudden as too much good news has been priced in. As noted last week, a 60+ P/E is not sustainable. Although in the near-term these stocks could yield poor performance, they have a structural advantage over smaller peers and will continue to gain share. Investors should make sure they are not heavily exposed after this rally. Profits only count if you take them. Long-term holders should not worry about the volatility. The Fed has our back and leaders lead.
The 2nd group is the downtrodden travel, leisure, restaurant, retail, energy and commercial real estate industries. For many reasons discussed ad nauseam, they are in purgatory until we get a vaccine that is readily available for the masses or some control of this outbreak. Recent spikes in case counts keeps this group from realizing their full potential. However, they have the most upside relative to normalized earnings power. That could be 2022 or 2025. No one knows the trajectory of the recovery.
Money printing can keep some of these sectors afloat, but it hardly makes them easy to buy in 2020 unless you have a long holding period. Gains could be substantial, but so could the time to realize them. Vaccine trial updates from Johnson & Johnson#, Pfizer# and Moderna are encouraging. More studies will be critical. The FDA is in a tough position. You want the vaccine, but will not have enough time or sizable case studies to really know if the “cure” is worse than the disease. Caution is warranted when you read the headlines of successful Phase I or II reports. We will get there and that’s when this pack takes off.
The last group are those stuck in between. It includes many industrial companies, consumer stocks and a portion of health care that have been trapped in no-man’s land. They collapsed in March and only regained a portion of those losses so far. As winners get sold here, funds are flowing into these names, especially the industrial segment.
The Transports are up over 5% this week while the Nasdaq is down 1.4%. Small caps took some money flow as well, advancing over 3%. Trucking stocks are at new highs. Copper and oil prices are now firming. International markets are showing strong moves as their economies reopen. Decent bank earnings this week have pushed the Financial sector up 3% as well. One week does not make a trend but this is good action. The broadening out of any rally improves sustainability. This area may contain the leaders that take us to new highs before year-end in the major indexes.
Before we finish the 2nd half of this year, we have another important event. The Presidential Election scene is about to ramp up. The past few months will feel tame compared to the next four, from a political standpoint. The former Vice President has been relatively quiet since Covid started, while Trump is never characterized that way.
Biden is expected to formerly announce his VP running mate on August 1st, only two short weeks away. Multiple debates will follow. In February, polls pointed to a Trump landslide as the economy was humming along and stock markets were making new highs. Incumbents do not lose unless the economy is collapsing or something drastic occurs. James Carville coined it, and it has proven to be accurate, “It’s the economy, stupid”. Post-Covid and a forced recession, Trump has lost that lead and then some. The chances of a Democratic sweep increase by the day. However, the poll leader in July does not mean much at this point. Much work will be done and many words will be said over the coming months that could change things.
Although neither President option would change the long-term growth rate of ~2%, the individual stock winners and losers could be vastly different. Defense stocks have been lagging the overall market lately. Budget maneuvering is sure to be different without Trump as more funds would go to Green projects or education plans. Solar firms would benefit.
Biden’s tax proposal includes moving the corporate rate from 21% to 28%. Social Security taxes on earnings above $400,000 would be raised. He has proposed an increase in capital gains and dividend taxes. Another idea is to remove the 2017 Trump tax cuts for high income earners. The biggest concern for heirs would be an added tax on unrealized capital gains at the time of death. Tax planning at year-end could get volatile. The anti-corporation far left agenda might pick up steam if Biden’s cabinet includes them. That being said, political comments today can be taken with a grain of salt. What a politician says and does are two separate things.
On the positive side, international relations are likely to be more cordial. As with most Presidents, spending will not be an issue. Infrastructure bills may finally see the light of day and be sizable. Construction and engineering companies would love this. Biden promises to cross the aisle during his term. We’ve heard this before, but Biden has been able to solve many partisan issues over his long career. Less media hostility equals more time spent on solving issues instead of all the bickering we’ve become accustomed to. Probably not good for New York Times subscriptions, but it helps with the endless headlines that lead to constant bickering.
Another four years of Trump means much of the same and then some. Without fear of losing in the next election, 2nd terms are filled with more legacy filling moves. A more aggressive China approach is likely. America First, or isolationism will increase. Shale discovery and expansion, price permitting, will follow. Another impeachment attempt could be in the cards as well. It is quite possible more Republicans distance themselves from the administration in hopes of a return to party normalcy. That could be good or bad, depending on the area in which you live.
Climate issues would continue to get pushed aside. Corporations have already picked up that baton though. Defense stocks will play catch up with the rest of the economy. Taxes stay low, which is good for profits and bad for budget deficits. Biden’s tax proposal would eliminate ~10%+ from bottom line earnings. That makes a fully valued market expensive overnight.
There is a lot to think about over the coming months. Until then, range bound action continues. Earnings updates pick up the pace next week. This adds to volatility. Wider swings in individual stocks and rotational action is all healthy. We’ll have some vaccine updates for you next week as well.
A big day for Germany as David Hasselhoff turns 68 today, while Chancellor Angela Merkel is 66. Donald Sutherland is now 85.
James Vogt, 610-260-2214