Weekly Update

Market Finally Pulls Back

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Published October 1, 2021

For the first time in a year, the stock market delivered a negative monthly return. We have written about the negative seasonality of September, which has proved out once again. October can be a dicey month as well, with wide swings in performance. The following note from Delta puts into perspective the current market environment while also reminding of the longer-term view. It is also important to note that the pullback in the market at this point has only been 5-7%. It is also important to realize that while the broad market indexes have shown little movement, almost 90% of individual company stocks have registered at least a -10% drawdown. The stock market has been much weaker for much longer than the market indexes show. That could mean that the market pullback is fairly brief – all depending on whether interest rates continue marching higher or not. Herewith is Delta’s view:

“September was a negative month for the U.S. stock market. For the third quarter, the S&P 500 traded nearly flat. Since last November, the S&P 500 appreciated on a steady trajectory to a peak closing valuation reached on September 2. With the mild (less than 5%) depreciation in the S&P 500 during September, the positive momentum in the market has dissipated. This can be measured by the current price of the index breaking down through various moving averages.

Technically speaking, the outlook for the U.S. stock market in the intermediate term (1-3 months) is “cautious.” If weakness persists, it will become bearish.

The longer-term outlook is positive. Technically speaking, the S&P 500 is well above its 200-day moving average which is a long-cycle technical indicator. Macro-economic data shows continued economic growth even when considering a possible Federal Government shutdown, global supply chain issues, rising labor costs, future Fed tightening, less government fiscal stimulus, rising inflation and rising interest rates.

Based on your investment objectives, risk tolerance and time horizon, and intermediate-term cautious/long-term bullish outlook may stimulate different responses. For risk-averse investors with a shorter time horizon, the intermediate-term cautious technical signal might drive the investment allocation decision. For investors with more appetite for volatility and a longer investment horizon, you may wish to focus more on the bullish long-term outlook.

Longer Term Growth and Valuation

We invest over time with the expectation that our investments will appreciate. Appreciation is driven by sustained profit growth. Today, in this market environment, we are seeing growth. For example, consider Amazon (AMZN).

  • Amazon revenue for the quarter ending June 30, 2021 was $113B, a 27% increase year-over-year.
  • Amazon revenue for the twelve months ending June 30, 2021 was $443B, a 38% increase year-over-year.
  • Amazon annual revenue for 2020 was $386B, a 38% increase from 2019.
  • Amazon annual revenue for 2019 was $281B, a 21% increase from 2018.
  • Amazon annual revenue for 2018 was $233B, a 31% increase from 2017.

Amazon is benefiting from the secular transition from bricks-and-mortar shopping to on-line shopping. Amazon is benefiting from the transition to cloud computing. Amazon is benefiting from the transition to on-line advertising driven by artificial intelligence. Amazon spent $42 billion on research and development in 2020 to remain a leader in areas of rapid growth.

The growth numbers above are typical of many large-cap technology stocks. The average year/year sales growth of Facebook, Apple, Amazon, Microsoft and Google (FAAMG) was 16.5% from 2015 through 2020. It is projected to be 26% in 2021.

Today’s market leading technology companies are less expensive relative to earnings than the leading companies of the Tech Bubble (2000) and the Nifty 50 (early 1970s). The chart below shows the 24-month forward P/E multiple of the leading companies at these periods.

Market leading companies 24-month forward P/E

When comparing the earnings yield (the inverse of the P/E) to bond yields (we use the 10-year treasury as a general measure of interest rates), today’s market leaders may actually look “cheap.” The earnings yield for the FAAMG stocks is 3.7% vs. 10-year treasury of 1.5%. Ahead of the Tech Bubble, the earnings yield of the market leaders was 1.8% vs. 10Y of 6.7% and in 1970 the earnings yield of the Nifty 50 was 2.8% vs. 7.8%.”

Market Update

Stocks were mixed to begin the week as cyclical stocks showed well while tech shares struggled under the weight of rising interest rates. Surging oil prices and the rising rates are driving energy and financial shares upward. The S&P closed Monday off -0.3%. The cyclical strength was not enough Tuesday as sellers took control sending broad market indexes lower by -2%. The Nasdaq slumped almost -3%. A slim rebound Wednesday led by defensive groups left the S&P higher by only +0.2%, little solace for bulls given the prior day’s harsh treatment. Stocks closed lower again Thursday to close the month of September. A -1.2% slide brought the monthly tumble to -4.8% as the coming shift in Fed monetary policy combined with a tired market and weakness in China delivered the month to the bears. A rise in consumer spending and positive news from Merck on a Covid-19 pill Friday sent consumer stocks upward Friday to begin the month of October. Strength in airlines and hotels kickstarted a broad rebound en route to a +1.1% lift.

Stocks gave back the prior week’s gains with the S&P 500 (SPY) slipping -2.18%. The Nasdaq 100 (QQQ) suffered a loss for the fourth consecutive week, slumping -3.62%. Smallcap stocks (IWM), heavier with finance and energy stocks, continued to outperform, holding relatively flat at a -0.28% weekly move.

Warm wishes and until next week.