Published March 5, 2021
The market’s preferred narrative has changed over the past month leading to a selloff in the tech & consumer-heavy Nasdaq. When the current market rally started way back in April 2020, the argument was that the stable earnings growth and global presence of the mega-cap tech and consumer stocks like Amazon, Facebook, Nike, et al. would be the best place for stock investors to park their money. These brands are substantially online or ‘digital’ in their business operations, and less likely to be impacted by the new stay-at-home lifestyle.
That market narrative shifted when the first Covid-19 vaccine approval came through. This shift accelerated the economic recovery story. That story benefits cyclical stocks like materials, energy, and banks. It also sends interest rates upward as demand for money increases. The blue line in the chart below shows the upturn in U.S. interest rates. The red line on the chart shows German interest rates, which remain negative. All other things equal, a faster rising blue line pushes the U.S. dollar upward, at least relative to the Euro. We have seen that move take hold this week.
The sharp rise in interest rates has turned the tables on the Nasdaq heavyweights, those stocks which were so in favor nine months ago. Back then the idea was that the earnings growth for these stocks was being accelerated by the increase in online shopping, etc. Academic investment theory tells us that a stock’s value is determined by taking expected future cash flows/earnings and dividing that by a required rate of return, with that rate of return being notably influenced by interest rates. With interest rates effectively at zero, those expected earnings and cash flows essentially are divided by nothing – e.g. an infinite stock price. Throw in the massive uncertainty of the pandemic; and the relative certainty that people were stuck at home with the internet as the only way to spend money – online retailers become the stocks of choice.
Fast forward to mid-February 2021 and the script has completely flipped. Investors see a coming economic recovery boom as populations get vaccinated and return quickly to their normal patterns of spending. Couple that with extraordinary government stimulus programs, and you have the making of a powerhouse bull market in cyclical stocks. Interest rates spike in anticipation of this recovery. Now, with a positive number to divide those expected cash flows and earnings by, suddenly the ‘infinite’ price of the Nasdaq heavyweights no longer holds. The Nasdaq rolls over and quickly drops -10% as the chart below shows. We are already at a point of significant support though – about $300 on the QQQ as we see below.
As we go to press, this $300 level is holding and a good bounce has occurred. Will this be another bullish v-shaped recovery? Or will the Nasdaq bounce around for awhile before launching another run upward? Or is this only the beginning of a more protracted downtrend as investors shift to yet another market story? Time will tell and our models will follow along, hopefully staying (mostly) on the right side of the market’s trend.
Market Update
Stocks rebounded from the prior week’s selloff with their best day in months. Monday’s +2.4% advance was pinned on a step back in interest rates. Rates have been rising at a torrid pace recently. Fears of higher inflation stoked by an expected resumption of economic activity amid massive government stimulus spending are pegged as the culprit. Commodities from copper and lumber to oil have been shooting higher as recovering economic activity often outpaces the ramping supply. Stocks gave back -0.8% Tuesday as the optimism faded. And again Wednesday with another -1.3% slip, this time seeing the Nasdaq drop by 2x that amount as the selling of tech shares resumed on a tick upward in interest rates. Same story Thursday with investors disappointed that Fed Chair Powell seemed unfazed by the ramping inflation concerns, viewing them as transitory. Friday brought an end to the selling. Stocks began the session dropping further before a solid recovery left the broad market higher by almost +2%.
A volatile week as momentum stocks got clocked amid a continuing move away from growth stocks and toward more value-oriented names. The Nasdaq 100 (QQQ) was down as much as -6% before rebounding to close the week off a relatively tame -1.67%. Smallcap stocks (IWM) held almost flat at -0.27%; while the S&P 500 (SPY) managed a positive week (+0.86%) as energy and financials continued to benefit from the rotation out of tech stocks.
Warm wishes and until next week.