Published June 18, 2021
This year’s stock market has been all about rotation with money moving into value stocks and out of growth stocks. The narrative has been that rising inflation would push up interest rates. The hike in rates in turn raises the denominator of the classic stock price valuation (e.g. earnings/interest rates) which devalues high-flying growth stocks. The beneficiaries of this narrative have been cyclical sectors like materials, industrials, and energy. This week that narrative took a beating. The Federal Reserve merely hinted that the likelihood of interest rates rising two years from now, out in 2023(!!), was higher than they previously thought. Markets sent interest rates and the U.S. dollar sharply higher on this new idea (see far right of chart below for the dollar’s big jump).
This sharp move higher in the U.S. dollar undid the bullish moves in materials and industrials stocks. The charts below show these sectors selling off below their medium-term trendline. With the cyclical sectors no longer working, money rotated back into the perceived safety of tech/consumer stocks.
Prior to the Fed meeting, inflation fears were already subsiding as copper and lumber prices came off their recent highs (see these commodities breaking their trendlines below). Indeed, interest rates had been falling as investors came to believe the Fed’s view that inflation would be a temporary feature of the re-opening economy. Or, investors became concerned that commodity prices have risen so sharply that there is a danger consumers will pull back, slowing the economic re-opening.
And even after the Fed meeting, the move higher in interest rates, while big for the day, only pushed rates back where they were a few weeks ago (see chart below of the five-year interest rate).
However, the net effect of this substantial shift in sentiment was to leave the S&P 500 flat, trading where it was two months ago. Recall that 20% of the S&P 500 is held in only FIVE stocks – e.g. Apple, Microsoft, Amazon, Facebook, and Alphabet (Google). The shift of money back into these “safe” stocks had an outsized influence masking the underlying turmoil in the market. As our focus Nasdaq 100 (QQQ) is even more heavily influenced by these five heavyweight stocks, the Nasdaq appeared oblivious with the index hitting a record high while everything else was selling off.
The bottom line of all of this is that investors and stocks remain mired in an uncertain environment. The economic re-opening is positive, of course. But investors have already largely priced in that re-opening. They do not know what comes next. And now, they realize that the Fed won’t keep interest rates at zero forever.
Growth stocks continued their recent run Monday, posting their 7th consecutive gain, with the Nasdaq rising +0.7% while shares of cyclical financial and materials companies fell back. That script flipped a bit Tuesday as the Nasdaq handed back Monday’s gain. Energy stocks rose on the back of continued strength in oil prices. Oil began the year just shy of $50 and now trades for more than $70 per barrel, a reflection of the surge in demand while supply struggles to catch up. Retail sales fell in May as spending appeared to shift toward services with restaurants and other entertainment options reopening. Markets reacted strongly Wednesday to this week’s Federal Reserve meeting. The central bank’s new forecast showed an expectation of two interest rate hikes in 2023, a higher rate curve than previously published. Interest rates ripped higher on the announcement, pressuring commodities and rate-sensitive stock sectors. The S&P 500 touched lower by -0.5%. One day later and investors continued pulling money out of rate-sensitive cyclical sectors while buying the FANG stocks. The Nasdaq rose +0.9% Thursday while the Dow Industrials fell a similar amount. A pre-market interview Friday with one Fed member reaffirmed the central bank’s shift in focus toward the timing of rate hikes. Stock investors sold on the news sending stocks lower by -1.3%. It was a broad-based pullback with all indexes and sectors falling. The money rotated into bonds causing yields to fall. The 10-year Treasury bond posted its fifth straight week of lower yields, an odd divergence given the week’s concerns about rising rates.
A negative week for stocks led the S&P 500 (SPY) lower by -1.89%. The Nasdaq 100 (QQQ) held a slim +0.41% gain. Smallcap stocks (IWM), more heavily weighted toward cyclical sectors, slumped -4.13%.
Warm wishes and until next week.