Nolte Notes 9.14.2020

Nolte Notes 9.14.2020


Like the dog that finally caught the car, investors in the markets are wondering now that the market is/has corrected, now what? It is not likely that the correction is yet over, as many of the highest-flying stocks have “only” dropped 15-20% and remain significantly higher on the year. There has been a bit of rotation toward the more beaten down portions of the markets, although nothing is standing out as a clear winner. Back at the economy and virus updates, the weekly jobless data was less than inspiring. The weekly jobless claims have been dropping at an ever-slower rate and last week were essentially flat from the prior week. The flipside is the monthly report on job turnover (JOLTS), which shows plenty of openings and a low level of job layoffs. Finally, the inflation data was a bit hotter than expected, which is not a surprise, as the economy continues to open. The ability of businesses to increase prices after cutting during the pandemic is just coming back. The coming week is loaded with economic data and includes the Fed meeting, where we hope to find out more about how the Fed is likely to handle monetary policy. Finally, retail sales will be watched closely for an indication of consumers appetite to spend even as the extra government aid rolled off in July.

The SP500 has declined just under 5% so far this month, which qualifies as roughly halfway to an actual correction. Of course, there has been more pain in tech stocks, as they have jumped more than the rest of the market since March. As a result, more “value” strategies have been winning the performance race over the past two weeks. We have seen this shift a few times since March, as growth takes a breather for a few weeks and then comes roaring back. The market internals favor a continuation of the corrective nature of the market, with the net advancing stocks to declining at their lowest levels since early July. Half of the SP500 stocks are above their short-term average price which is well down from over 80% at the end of August. As investors begin to eye the November election, we expect stocks to be very volatile day to day, with a likely downward bias over the next few months.

Yield spreads, specifically the difference between the 2 and 10-year treasuries, have been very instructive in pointing the way for the economy. Historically, coming out of a recession, the difference in yields of these two securities get quite large very quickly. These “spreads” began rising quickly as the financial crisis unfolded, indicating the flood of money coming from the Fed. It took nine months to increase nearly 2 full percentage points. Today, after six months of “recovery” the spread has increased by less than half a percentage point. The implication is that instead of rocketing out of a recession with inflationary forces rising, this recovery is likely to be very tepid with little inflation. What this means for fixed income investors is a long period of essentially zero interest rates on savings and low interest rates in general for the next few years.

Signs of a still weak economy can be gleaned from the performance of the energy sector. This is the most sensitive to economic activity. After peaking at yearend, energy prices fell nearly every week before finally bottoming at the end of April and doubling over the following two months. However, since the end of June, oil prices have increased very modestly and by last Friday, closed at its lowest levels since mid-June. Technology joined energy as the worst performing sectors within the SP500 last week, while basic materials and industrials were at the top. Given the size of the technology sector at over 25% of the SP500, it will be the tail that wags the performance dog for the market. Some defensive sectors, like consumer staples and utilities (a bond surrogate) should hold up while the other parts of the market go through its normal corrective pattern. At this point, we expect nothing more than a correction, but that could change if the economic data fails to impress investors and the yield curve (described above) does not get steeper soon.

The repositioning of portfolios, taking profits in technology focused funds and shifting toward more value investments will continue IF the correction is more than past “head fakes” that we have seen since the March bottom. Bond investors are likely to see modest returns in the years ahead due to the very low interest rate environment today.

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.