CWS Market Review – June 12, 2020

”We’re not even thinking about thinking about raising rates.” – Fed Chairman Jerome Powell

Last week’s issue of CWS Market Review was unusually prophetic. I said there’s a good chance that our Buy List would soon be positive for the year. Indeed, that happened two days later.

In that issue, I also said that the National Bureau for Economic Research might confirm the start of the recession before the end of the year. They did it on Monday. The expansion lasted 128 months.

I also noted that the Nasdaq Composite had just made a new all-time high. This week, the index went on to break 10,000 for the first time ever. The index started life in 1971 at 100. It took nearly 50 years to become a 100-bagger.

I also discussed the recent surge in cyclical stocks and wondered if the cycle had finally turned. On Thursday, however, cyclical stocks were severely punished as the market suffered its worst day in nearly three months. The S&P 500 plunged by 5.89% to close just above 3,000.

What caused the selling? We can point our fingers at the Federal Reserve, which met this week. Chairman Jerome Powell’s pessimistic outlook threw cold water on the market’s recent rally. There are also concerns that the long-feared “second wave” is starting to form.

On Thursday, the S&P 500 fell for the third day in a row. A three-day losing streak isn’t that big a deal, but we haven’t had one in 94 calendar days. That’s an usually long stretch. I guess we were due for one, and it came hard. In this week’s issue, I want to take a closer look at what’s been happening to the market and what we can expect going forward.

Cyclicals Get Crushed

One of the keys to understanding the stock market and investing is that the market tends to move in broad cycles. This happens as the market gets attached to a thesis. Let’s say the market convinces itself that the economy is gradually improving.

With that, we’ll see a fairly standard playbook. A rising market. Leadership from industrials and cyclicals. Lower bond prices. Higher yields and higher commodity prices. Greater pressure on the Fed to raise rates.

That’s the standard. Of course, each cycle will have its own peculiarities. Since March 23, the strong rally has been based on the idea of a diminishing threat from the coronavirus. Of course, that thesis isn’t completely unexpected since the rally is largely reversing the bear market which the coronavirus first caused. X is followed by negative X.

Here’s a good example of what I mean. This is a chart of the Zoom Video Communications (ZM) divided by the S&P 500 ETF, along with Middleby (MIDD) divided by the S&P 500 ETF.

When the lines are rising that means those stocks are beating the market. Conversely, when they’re falling, they’re lagging the market. If you examine the charts, you’ll notice that they tend to move in opposite directions. That’s the key point I want to get across.

In the age of the coronavirus, these two stocks are nearly polar opposites. I chose Zoom because it’s profited greatly from the lockdown, whereas Middleby has suffered. What’s been good news for one has been bad news for the other. (Zoom, truthfully, probably isn’t the best example for this exercise because the bullish trend has been so powerful, but even so, the cycle is still visible.)

Once these cycles get established, there will be strong contra-trend days. That’s a fancy word to say that everything that had been doing well gets crushed one day. At the same time, all the laggards suddenly find themselves in the spotlight. Or to quote more authoritatively, “So the last shall be first, and the first last.” As the thesis of the rally is debated on Wall Street, we’ll constantly see a tug-of-war between trend and contra-trend.

That’s exactly what we got on Thursday. It was a classic contra-trend rally. I’ll give you an example. If we look at High Beta stocks, these are stocks that tend to move around the most, and they got crushed. The S&P 500 High Beta Index lost more than 10% on Thursday. The High Beta sector is close to being an all-purpose anti-Covid sector. Whenever news breaks that the virus is fading, you can be sure High Beta will shine.

Within the stock sectors, the biggest loser was energy stocks. The S&P 500 energy sector lost over 9% on Thursday. In fact, the four worst-performing sectors on Thursday were (in order) Energy, Financials, Materials and Industrials. If you recall, these are the exact four that I told you last week comprise the cyclicals universe.

It’s these cyclical stocks that had performed so well that got their heads chopped off on Thursday. The price action on Thursday wasn’t a minor pushback, either. The bears gave these stocks a super-atomic wedgie. Callie Cox noted that on the NYSE, decliners led advancers by 1,800. That’s the most in nearly five years. In other words, the bears were going after everyone.

Last week, I asked if the cycle has finally turned. This week told us, “maybe not.” I wish I could be more emphatic in my predictions, but the facts won’t allow for it. Until we know more, we should maintain a conservative approach to our investments. Three of our stocks that look particularly good right now are Stepan (SCL), Middleby (MIDD) and Stryker (SYK).

Mr. Powell Spooks the Market

As I mentioned earlier, the Federal Reserve got together this week. On Wednesday, the Fed released its policy statement. As expected, there wasn’t any change to its policy. Rates are already rock bottom, and I doubt they’ll soon go negative.

What caught Wall Street’s attention were comments made by the Fed Chairman in his post-meeting press conference. Jerome Powell was unusually blunt. He said the Fed isn’t “even thinking about raising interest rates.” The Fed probably sees rates staying near 0% through this year, next year and the year after that. On top of that, the Fed will most likely continue to buy up bonds at a frenetic pace. Central bankers rarely speak so forthrightly.

This is somewhat ironic in that Mr. Powell was often harshly criticized by President Trump (who appointed him) for not lowering rates. There’s another story going on. A lot of the Fed’s job involves signaling. Right now, the Fed wants to make it clear to Wall Street that it will not stand in the way of any nascent recovery. Wall Street took the message to mean that the economy is more precarious than the bulls believe. Then on Thursday, it was as if three months of frustration from the bears came out all at once.

One big change between now and the market in March is that daily volatility has dropped significantly. The Fed also released its economic projections for the next few years. The central bank forecasts a very robust recovery. Of course, that’s coming off a very steep low.

The economic news is still quite scary. The latest jobless-claims report came in at 1.542 million. That’s the tenth weekly decline in a row. There was good news in last Friday’s jobs report. It showed an increase of 2.5 million jobs, although the Bureau of Labor Statistics conceded there were some errors in this report. We’ll have more details next month. (It’s not some conspiracy. It’s just hard to get the right data during extreme events.)

On Wednesday, we learned that consumer prices fell again last month. That’s the third monthly decline in a row. The good news is that we’re not too far from the normal range. My fear was that we could be near a deflation spiral where lower prices begat even lower prices. Things are getting back to normal, but it will take time.

That’s all for now. On Tuesday, we’ll get the retail-sales report for May. The previous report was terrible. Hopefully, that was the nadir. We’ll also get the latest report on industrial production. Then on Wednesday, we’ll have the latest report on new-home sales. Thursday, of course, will be another report on jobless claims. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by on June 12th, 2020 at 7:08 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.