Nolte Notes 6.8.2020

Nolte Notes 6.8.2020


The “game” of estimating economic numbers is rather humbling. There are so many variables, revisions and things not accounted for that hitting the actual estimate is a lesson in futility. Take the jobs report, in a “normal” month, the margin of error is usually 10-20,000 jobs. As states open slowly and get caught up on past filings for unemployment, it was estimated that jobs were still being lost in May. Payrolls actually expanded and the unemployment rate fell. The jobs report was much better than expected and created a surge in the stock market, capping the best three-week period since 2009. The employment report was one of many that were “better than expected” over the past two weeks. Many of the absolute numbers were awful, but vs. what was estimated, they were better. Wall Street operates in the world of recent data trends. If the trend is better, things are getting better and stocks should be rising. If the trend is getting worse, Wall Street looks around for the Fed to help by cutting interest rates and stocks rise. Heads they win, tails you lose. It does not make sense for those looking in from outside “the club”, but Wall Street has always moved to its own beat.

The last time we have seen the markets put together a two or even three-week run like this was coming off the 2009 bottom. Unusual in that the SP500 has already run higher by 40% over the past 50 trading days. Many are calling this a “blow-off” top that will reverse by August as everyone piles back into the markets. However, the rally is broadening out rather than getting narrow. The former leaders (technology and healthcare) are starting to take a back seat to the more cyclical portions of the market. Volume increased as the markets rose and the number of stocks rising vs. falling has been decidedly bullish. That does not mean stocks continue to race higher, but that any inevitable rest that may happen should be a good time to add to equity positions. It is crazy to think that the economy is contracting by over 5% and unemployment is likely to remain over 10% by yearend, yet the markets are within a stone’s throw of yearend or all-time highs. Such is the power of “free” money from the Fed.

Confirmation of the shift in the equity markets can be seen in the bond market. Even as the Fed has been regularly buying bonds and bond ETFs, interest rates are rising. The 10-year treasury is approaching 1%, which is not a big yield, but it was below 0.50% just a few weeks ago. Always worrying about something, investors may begin to be concerned that higher yields become competition for stocks as they can garner “safe” returns more than stocks. We are a long way away from that, but as the stock market rises and valuations get stretched, bonds will become a much more interesting asset class again. The Fed continues to hold the key and will be meeting this week to discuss interest rate changes (expect nothing), but may begin to explain what their expectations are for the remainder of the year, which will be very interesting to hear.

We saw signs of rotation to other parts of the markets two weeks ago and last week it came through in spades, with small-cap doubling the return of the SP500. International did very well as did the beaten-down financials and energy sectors within the SP500. The larger the stock, the worse the performance. It is this rotation that may provide some fuel for further gains. The largest stocks held up during the market decline in March and are now expensive relative to many other parts of the markets. The disparity between estimated returns of the largest US stocks (roughly 2%) and small stocks (over 10%) for the coming five years is at the widest it has been since 2000. That marked the beginning of a seven-year run for value, international and small stocks that then culminated in the financial crisis. These big market declines (Tech bubble, financial crisis, Covid) tend to be periods that mark a shift in market leadership. We may be in the early stages of that shift today.

So much for a market rest last week, as the SP500 jumped 5%. Still looking for a rest, but the longer-term outlook for stocks outside of the largest US stocks is brightening. Diversification away from large tech and growth names may allow for better performance in the months and years ahead. The Fed will be important to watch later this week about their plans to continue to support the financial markets.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.