Weekly Update

New Hurdles Emerge for Stocks

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Published September 25, 2020

After a summer spent surging higher on economy re-openings and optimism for growth, stocks have entered a typical September slump. While we could just chalk it up to typical pre-election caution, there are fundamental factors that have emerged to challenge the market perhaps more seriously than usual.

The surge over the past couple of weeks in European coronavirus cases have several of those countries contemplating restricting economic activity to slow down the virus spread. This news has unwound a key leg of the market’s bullish summer narrative. That narrative embraced a recovering global economy and rising inflation. The combination of those two pushed share prices of cyclical sectors like industrials and materials, beneficiaries of global growth, as well as financials and materials (again), beneficiaries of rising inflation. The chart below shows the rising blue line from March to August. This blue line comprises cyclically-driven materials and mining companies. The red line shows the U.S. dollar, which was declining throughout this rally in cyclical stocks. The U.S. dollar was declining because of the expected recovery in global economies as they reopened.

US Dollar and cyclical industrial and materials stocks

This was all working splendidly for investors until we turned the calendar to September. European coronavirus cases surged. The Euro slumped as a result. This led the U.S. dollar to reverse course and begin rising, thus putting new pressure on the cyclical industrial and materials stocks. The slumping economic narrative took the wind out of the sails of the rising inflation idea. This hit financial and materials stocks (and precious metals).

With the FANGMA stocks in the Nasdaq having risen to nosebleed levels, those stocks were ripe for any shift in bullishness. September has brought that shift in spades. The Nasdaq 100 (QQQ) is down just shy of -10% this month; the S&P 500 and small-cap stocks off -7%. International stocks have still held up better (-3%). We have another 5-6 weeks until the election. We don’t expect any real relief in this choppy, struggling market until after Thanksgiving, if history is any guide. Fortunately for our subscribers, this choppy environment often proves profitable for our model.

Market Update

A selloff in Europe kicked of trading this week as countries there see a surge in coronavirus cases. The ensuing 2-3% drop at the market open in the U.S. was pared to -1.2% by the close. Cyclical sectors and commodities were hit particularly hard. Money rotated back into Nasdaq stocks as the cyclicals sold off. The Nasdaq closed flat as a result of the rotation. That modest afternoon recovery carried over into Tuesday with stocks rebounding to recoup Monday’s losses. However, the buying mood was brief as selling returned Wednesday. The S&P 500 slid -2.4% with the Nasdaq falling a full -3%. A Justice Department proposal to curb legal protections for internet companies might have played a role in the Nasdaq selloff. Also hampering stocks, hopes for a new Congressional stimulus package have vanished in recent days. Market participants now do not expect any action until after the election. A slim +0.3% bounce Thursday came from a positive report on house sales, which remarkably hit a 14-year high as many office workers now work from home, and interest rates remain at rock-bottom levels. Stocks bounded to solid +1.6% gains Friday, perhaps on news of progress toward a Covid-19 vaccine and also a bullish note on cruise lines, suggesting economic recovery ahead.

For the week, stocks posted mixed results with the S&P 500 (SPY) dipping -0.58% while the Nasdaq 100 (QQQ) returned to its leadership position with a +1.91% gain. Small-caps (IWM), full of financial and cyclical stocks, suffered a -4.12% slide.

Warm wishes and until next week.