Taking a step back, let’s look at some of the crazy action this year. In March, we had the fastest bear market decline and the highest percent of down days ever. From that bottom, we bounced back with the fastest return to a new bull market in history. Obviously, that means it was the shortest bear market of all time. This market reversal produced the best five months on record. Then the Nasdaq dropped 11% in three days which, technically is considered a correction. And you guessed it, the fastest ever coming off a bull market high.
Turning to last month, stocks gave investors their best August in four decades with an 8% S&P return and a 10% Nasdaq advance. All sectors were green, except for energy and utilities. Obviously, technology led the way, but the rally was very broad based. Consumer discretionary stocks, industrial and communication service sectors were all up over 8%.
Trees do not grow to the sky though. With rapidly ascending chart patterns in the tech arena looking more and more like the Y2K bubble, the aggressive decline this month is actually good news. Consolidating gains while earnings play catch-up to extreme valuations is quite normal. Investors rightly plowed money into predictable growth stories during the pandemic. Low interest rates support higher P/E’s. So far, P/E ratios have risen by about 15 points for the Technology sector. There isn’t much room for more.
Take Apple# for instance. After a ridiculous 20%+ rise following their split announcement, it was trading at 42x current earnings. The stock has ranged from a 12 – 16 P/E for a decade. Certainly, they are more than just a cellphone manufacturing company today. Investments into the app store and other service businesses have created a more predictable revenue stream instead of a cyclical hardware firm. Apple does deserve a higher multiple but, a straight line upwards is too much for any stock to hold on to. Much of the same can be said for all of FANGMAN to an extent.
Wednesday yielded a nice bounce after the quick ~7% decline in the S&P. Yesterday’s morning action was very positive as well. However, selling ramped up later in the day and we’re back to testing the low end of the range. A failed skinny bill Senate vote, comments from Mitch McConnell on lack of optimism for a bipartisan stimulus bill and an uncertain control of the Senate post-election were deemed reasons the S&P went from +0.8% to finish down -1.8%. The Nasdaq had a 4% downside reaction as well. Momentum names declined the most, yet again.
Some proceeds from these sales are flowing into other areas that offer a more favorable risk/reward proposition. Areas where valuations are not extended. The Russell 1000 Value index is still down nearly 10% this year. Taking out the FANGMAN group, the S&P would also have a negative return. Plenty of stocks outside of the technology and housing world are trading below their long-term intrinsic value. To get back to fair value, we have to get past Covid. Investors are starting to realize this is happening, albeit slowly.
The new bull market is already broadening out to some extent. Economically sensitive names like Deere, Caterpillar# and FedEx# are near new annual highs. Consumer companies like McDonald’s#, Delphi Automotive and Restoration Hardware made new highs yesterday as well. 90+ stocks are up 40% this year. It’s not all technology anymore.
As we get further away from lockdowns and consumers start to spend those savings, we’ll have a more diverse set of leaders. We’ve noted numerous times, trillions of dollars in stimulus were thrown into the system and massive amounts of borrowing with ultra-low interest rates. Similar to Fed Fund rate cuts, these things take about a year to fully impact an economy. Assuming Covid research and treatment options continue to impress the regulators, we may be looking at an economy firing on all cylinders next year.
In the nearer term, momentum controls the day. Volatility remains elevated. The longer the VIX is above 25 (currently at 30), the longer this correction will last. I see three major concerns holding us back: election uncertainty, a delayed, or possibly cancelled, stimulus bill, and extended valuations. Together, these concerns may limit upside for weeks, if not months. Each one of those factors is unlikely to be solved soon.
As polls tighten in critical election battleground states, we’ll be lucky to know the winner on November 3rd. Upcoming debates could push the needle in either direction. Polls have not been very accurate for major events over the past several years but, most have Biden handily ahead. However, when you drive around or see political rallies, it’s Trump with the enthusiastic voters. It is a wide open race today. This also suggest that the Senate race is also wide open. Investment considerations that impact in certain segments of the market are quite different depending on who wins.
Valuations remain elevated in leadership, mega-cap names. Even with an improving earnings picture, valuations of for many of these firms must come down before anyone can consider them cheap. As noted, there are plenty of areas outside of the momentum trade that offer favorable, long-term, values. We could be in a period where the average stock starts to outperform the market cap weighted averages.
A stimulus bill should be the easiest, but no one wants the “other side” to get credit, regardless of how much small businesses and displaced workers may need it. Recent employment data is also making it harder on budget hawks to be bullied into another round of money printing. Job openings as a percent of the labor force are already back to 2018 levels. In other words, there are not enough skilled workers to satisfy hiring needs. Historically, this is a leading indicator for overall employment going forward. The sub 9% unemployment rate for August is below most economists’ expectations for the end of 2020. Time will tell just how many more small businesses close but, there are plenty of jobs to be had today if you have the right skills.
Over the long-term, a successful continuation of reopening the economy, positive Covid treatments, declining death rates, and massively supportive monetary and fiscal stimulus points to a healthy rotation into more economically sensitive industries. However, that does not mean the go-go tech stocks will go down further. Companies that benefit from the new normal will eventually win out. Until then, we wait for Jim Meyer’s 2-day rule. We build shopping lists of world-class operators. We nibble at companies to own for the long-haul that are nearing fair value. Futures are strong this morning. Let’s see if they can hold the entire day this time.
A musical birthday as Ludacris, Harry Connick Jr and Moby turn 43, 53 and 55 today.
James Vogt, 610-260-2214