Weekly Update

Correcting Through Time

Tagged: , , , , , , , ,

Published March 26, 2021


Market corrections are typically defined as a decline of at least -10%. But they can also be corrections “through time”. A case in point is the chart of Amazon below. After leading the way higher for stocks from the initial Covid-19 plunge, Amazon has traded sideways for the past nine months, correcting in time. The ‘correction through time’ is a market or stock trading sideways while earnings catch up. Though Amazon might be considered expensive by some measures, each quarter of stellar earnings growth makes the stock price more and more reasonable. Eventually, the stock becomes relatively cheap and buyers return to kick off the next leg higher.

Amazon correction through time

A correction through time can also be referred to as “consolidation”. Either way, it is a period where the market digests the new price level, looking for some new catalyst to kickstart the next rally. We have seen this in the broad stock market. While Amazon and other megacap tech/consumer stocks led the market out of the Covid plunge, they stalled out last summer to digest their sharp price rally. As they rested, banks and cyclical stocks took flight to carry the ball for the broad market. This passing of the leadership baton can be seen in the chart below of the Megacap index. The tech/consumer behemoths account for 25% of this Megacap index. Nonetheless, the index was able to benefit from the new rally led by banks and cyclicals. The index has found a new resting place over the past few weeks, awaiting the next new push.

New rally led by banks and cyclicals

As confirmation that this resting phase is not limited to only the market’s largest stocks, the small-cap stocks are also taking a breather. After two years of underperformance small-cap stocks have been embraced by investors. Once the price level cleared $170 on the chart below, a torrid +30% run higher over only three months commenced. That type of blast higher deserves a bit of rest, wouldn’t you say? We rest now.

Small-cap stocks are taking a breather

A big difference between the correction through time and a sharp price correction can be the relative lack of market anxiety. While the Nasdaq has dropped back -10% over recent weeks, the Volatility Index (VIX) has registered no concern. The VIX has eased back to the closely-watched 20 level, its lowest since the pandemic began.

Volatility Index has registered no concern

Our conclusion is that the market is thus far simply digesting the November-January price run, finding new reasons to be cautious, building a new wall of worry. Scaling that wall will bring the next leg higher. Of course, we never know how big that wall of worry gets (e.g. how far the market declines before rebounding). Nor do we know what might kick off that shift in sentiment to a new bullish phase. Thankfully, we have our model to take the guesswork out of it for us. We will ride the next wave, just as we did the last, and have for almost twenty years now(!).


Market Update

Interest rates continued to be the focus of markets this week, with the sharp recent increase in rates leading investors to sell riskier assets. A dip in rates Monday pushed tech stocks +1.2% higher. That gain was given back Tuesday as a rise in Covid-19 cases in Europe extended lockdowns in Germany. This shift threatens the global economic recovery story that has underpinned the rising stock and commodities markets. Oil prices tumbled -6% on the news with smallcap stocks suffering a nearly -4% rout. Oil prices recovered Wednesday, though stocks continued their slide with the Nasdaq down another -2%. The broader markets experienced much smaller drawdowns. Cyclical stocks found buyers Thursday in an afternoon rally that left the S&P 500 up +0.5%. Another positive day for cyclicals on Friday with banks receiving clearance to boost stock buybacks and dividends as they wish. A late-day push left stocks up +1.6% for the day.

The late Friday jump in stocks gave the S&P 500 (SPY) a +1.66% gain for the week. The Nasdaq 100 (QQQ) moved up +1.04%. The smallcap Russell 2000 index (IWM) cut its loss to -2.60%.

Warm wishes and until next week.