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Home Best Stocks to Buy Now

This what investors need to know about the recent stock market rally

by Elaine Mendonça
July 10, 2021
in Best Stocks to Buy Now
0
Stock market rally

Source: Getty Images

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Last week’s resiliency – a 1% one-day shakeout that was fully reversed Friday and then some – was just the latest example of how a persistent rally is sustained by flashes of concern that it is in jeopardy.

What, one might wonder, would have caused investors to be so concerned prior to Thursday’s tremor? The S&P500 had just completed a seven-day winning streak, propelling it to a record high and five consecutive quarters of at least a 5% gain.

However, the unexpected and unwelcome drop in Treasury yields reinforced the belief in a slowing global economy while undermining popular cyclical sectors. The rally’s breadth was rightly criticized, with statistics about how few stocks were trending higher in heavy circulation.

And this year’s erratic, indecisive sector and style leadership – first speculative-growth, then “reflation plays” in small-caps and cyclicals, followed by a powerful resurgence of stable mega-cap growth – has made it difficult for any group of investors to feel they had things figured out, keeping overconfidence at bay.

With bond yields squeezing lower toward a five-month low and countries re-imposing restrictions to combat Covid outbreaks, plenty of stocks were already down significantly by early Thursday, and the downside flush that morning made them oversold and ripe for a bounce.

Even with the S&P500 down less than 2%, roughly half of all S&P500 components were at least 10% off their highs, and more than 2,300 individual names made a one-month low, the highest such reading all year and usually enough to invite a strong bounce.

At the same time, the air leaking from economically sensitive groups had resulted in 10% corrections in transportation, homebuilders, and banks, relieving valuation and technical excesses but causing little net harm to the broad indexes, which were receiving support from breakouts in long-stagnant Amazon and Apple (together comprising more than 10 percent of the S&P 500).

Market rally
Source: Getty Images

 

This kind of gentle, almost choreographed ebb and flow may appear unlikely to continue, but it has lasted all year, putting a safety net just a few percentage points below the market as it has risen.

It has been a long time since there has been a 5% sell-off.

According to Ned Davis Research, the S&P500 is now on its second-longest streak in the last decade without at least a 5% pullback on a closing basis.

Nothing says such shallow dips and grinding progress can’t continue for much longer, as evidenced by the much longer streak from mid-2016 to early 2018. I’ve mentioned before that the market setup and behavior in 2021 are similar to the previous two post-election years, 2017 and 2013, with their low-drama uptrends and constant rotations among sectors and styles.

The famous “taper tantrum” of 2013 sent Treasury yields soaring (and then falling) on a hint of the Federal Reserve reducing bond purchases, triggering a brief 6 percent drop in the S&P before markets made peace with a gradual wind-down of QE. Does this sound familiar? In fact, the S&P500 was up nearly the same amount at this point in 2013 as it is now (15.9 percent vs, 16.5 percent).

Yes, things were different back then: equities were objectively cheaper, the S&P only reached its first decisive record high in 13 years that spring, and investors had lower equities allocations than they do now.

In 2017, anticipation of a corporate tax cut and the recovery from a 2016 industrial and earnings recession provided strong tailwinds, shielding the market from significant pullbacks until reckless bets against volatility spiraled and a crescendo of overconfidence built up before bursting in January 2018. Since then, a flash correction has resulted in more than a year of no net progress for the market, despite the fact that the economy and earnings have performed admirably.

This is why bulls should prefer the current market to stop short of excessive optimism and widespread investor confidence in the economic outlook.

Of course, no formal alarm is triggered when those dangerous thresholds are exceeded. This is, without a doubt, a fully embraced bull market, with full investor allocations to stocks and very low short interest.

However, tactical indicators are more muted, as brief shakeouts and quick rotations keep traders on their toes, and the sped-up, amplified economic cycle drives an unusually wide range of plausible GDP growth, inflation, and Fed reactions.

Keep your enthusiasm in check.

Bank of America's Bull & Bear
Source: Getty Images

Bank of America’s Bull & Bear Indicator has rolled over without entering the danger zone of reckless optimism and reckless risk-taking. It is now in the zone that existed in 2013-14, when the bull market was in a steady grind rather than a full gallop.

Wall Street professionals are mostly keeping expectations in check. The consensus S&P500 target for the end of the year has already been met, according to brokerage-house strategists.

FactSet’s John Butters tracks the implied S&P500 target derived from all individual sell-side analyst share-price targets. If the median 12-month target for each S&P500 stock is met, the S&P500 would be at 4803 in a year, up 9.9 percent from Friday’s close. That’s a fairly conservative overall outlook: According to Butters, the five-year average implied target for upside is 11.7 percent, the ten-year target is 12.3 percent, and the 15-year target is 14.5 percent.

Could this mean that stocks have risen so far that even Wall Street analysts don’t expect them to rise much further? Possibly. However, according to Butters, over the last five years, analysts have slightly understated stock performance using this metric. Analysts predicted less than 8% upside on June 30, 2020; the S&P rose 38% in the following year.

Of course, the absence of unbridled enthusiasm does not guarantee that the market will continue to tick higher without nasty switchbacks.

The S&P500 is just a third of a percentage point away from doubling from its low in March 2020, which was less than 16 months ago. Just because “everyone knows” the market is up a lot and the second year of a bull market is typically choppy and less generous doesn’t mean those facts aren’t important.

The recent rally’s unimpressive breadth was widely acknowledged and bemoaned, but that doesn’t make it a positive. No one knows the calendar, but the period from mid-July to September has undeniably been a less-rewarding period for equities over the decades.

Earnings for the second quarter are expected to be up more than 60% year on year, and rising full-year estimates have dragged down the S&P500′s valuation. That doesn’t mean stocks are cheap or immune to “sell the news” reactions to good news.

Still, in a strong but maturing bull market – with inflation-adjusted bond yields negative, companies flush with cash, and consumers sitting on extraordinary latent spending power – it is preferable to have such nagging concerns out in the open to form a healthy wall of worry rather than being ignored by an unquestioningly upbeat consensus.

Last week’s resiliency – a 1% one-day shakeout that was fully reversed Friday and then some – was just the latest example of how a persistent rally is sustained by flashes of concern that it is in jeopardy.

What, one might wonder, would have caused investors to be so concerned prior to Thursday’s tremor? The S&P500 had just completed a seven-day winning streak, propelling it to a record high and five consecutive quarters of at least a 5% gain.

However, the unexpected and unwelcome drop in Treasury yields reinforced the belief in a slowing global economy while undermining popular cyclical sectors. The rally’s breadth was rightly criticized, with statistics about how few stocks were trending higher in heavy circulation.

And this year’s erratic, indecisive sector and style leadership – first speculative-growth, then “reflation plays” in small-caps and cyclicals, followed by a powerful resurgence of stable mega-cap growth – has made it difficult for any group of investors to feel they had things figured out, keeping overconfidence at bay.

With bond yields squeezing lower toward a five-month low and countries re-imposing restrictions to combat Covid outbreaks, plenty of stocks were already down significantly by early Thursday, and the downside flush that morning made them oversold and ripe for a bounce.

Even with the S&P500 down less than 2%, roughly half of all S&P500 components were at least 10% off their highs, and more than 2,300 individual names made a one-month low, the highest such reading all year and usually enough to invite a strong bounce.

At the same time, the air leaking from economically sensitive groups had resulted in 10% corrections in transportation, homebuilders, and banks, relieving valuation and technical excesses but causing little net harm to the broad indexes, which were receiving support from breakouts in long-stagnant Amazon and Apple (together comprising more than 10 percent of the S&P 500).

This kind of gentle, almost choreographed ebb and flow may appear unlikely to continue, but it has lasted all year, putting a safety net just a few percentage points below the market as it has risen.

It has been a long time since there has been a 5% sell-off.

According to Ned Davis Research, the S&P500 is now on its second-longest streak in the last decade without at least a 5% pullback on a closing basis.

Nothing says such shallow dips and grinding progress can’t continue for much longer, as evidenced by the much longer streak from mid-2016 to early 2018. I’ve mentioned before that the market setup and behavior in 2021 are similar to the previous two post-election years, 2017 and 2013, with their low-drama uptrends and constant rotations among sectors and styles.

Stock market rally Indicators
Source: Getty Images

The famous “taper tantrum” of 2013 sent Treasury yields soaring (and then falling) on a hint of the Federal Reserve reducing bond purchases, triggering a brief 6 percent drop in the S&P before markets made peace with a gradual wind-down of QE. Does this sound familiar? In fact, the S&P500 was up nearly the same amount at this point in 2013 as it is now (15.9 percent vs 16.5 percent ).

Yes, things were different back then: equities were objectively cheaper, the S&P only reached its first decisive record high in 13 years that spring, and investors had lower equities allocations than they do now.

In 2017, anticipation of a corporate tax cut and the recovery from a 2016 industrial and earnings recession provided strong tailwinds, shielding the market from significant pullbacks until reckless bets against volatility spiraled and a crescendo of overconfidence built up before bursting in January 2018. Since then, a flash correction has resulted in more than a year of no net progress for the market, despite the fact that the economy and earnings have performed admirably.

This is why bulls should prefer the current market to stop short of excessive optimism and widespread investor confidence in the economic outlook.

Of course, no formal alarm is triggered when those dangerous thresholds are exceeded. This is, without a doubt, a fully embraced bull market, with full investor allocations to stocks and very low short interest.

However, tactical indicators are more muted, as brief shakeouts and quick rotations keep traders on their toes, and the sped-up, amplified economic cycle drives an unusually wide range of plausible GDP growth, inflation, and Fed reactions.

Tags: Best stocks 2021Stock market rallyWhat stocks to buy
Elaine Mendonça

Elaine Mendonça

My focus is on uncovering early-stage ideas with the potential to have a lasting impact. My educational background includes a bachelor's degree in finance, an MBA, and two tests completed - the CFA and CMT. Over the last nine years, I have managed my investment portfolio using fundamental analysis and value investing, emphasizing long-term time horizons.

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