The morning sell-off came to a logical halt, things became just a little disorderly, and the hardest hit areas of the market, which have been in “stealth correction” mode for several weeks, are outperforming or bouncing the hardest. However, this could be one of those “too cute” gambits that the market is putting to the test with another selling wave.
We can talk about delta variant and case rates and Olympics issues and China being charged with hacking Microsoft – all real issues in the air – but as the market digests it appears to be a collection of excuses for another gut check to the S&P 500′s 50-day average. This morning’s high was 4,340. It stands to reason that dip buyers would at least take a chance there.
Small-caps, ARKK, and homebuilders are outperforming in today’s market. Typical pain sequencing, but it could also mean funds closing shorts on beat-up groups as they tighten the leash on risk across the board.
Those looking for a good downside flush to suggest capitulation may have some options depending on how we close. More than 90% of NYSE volume to the downside is a good sign, as is an early put/call ratio above 1.0 for a while. More of this in the coming hours/days, and buying for a bounce is a better bet.
Is there much of a difference in terms of fundamentals? No, not at all. However, the fundamentals had not changed much for the better as the S&P made its latest 5% gain. The valuation is being supported as earnings continue to come in hot, but the question now is whether we’re running out of “all clear reopened” months ahead of expectations, well before fall/winter.
In the coming days, I expect the market to start making the case that the U.S. growth picture remains positive, that the drop in Treasury yields makes real yields even more negative, that quality stocks and chopped-up cyclicals offer some relative value, and so on.
Seasonal chop is on everyone’s mind, and it arrived just in time.
What are the next stops to the downside? A 5% drop brings the S&P back to around 4,170, right at the mid-April highs that capped the market for a few months.
The VIX is above 24, which corresponds to the index action exactly, but it is not yet a true overshoot. In volatile markets, look for signs of real stress. The VIX is now higher than the immediate VIX futures contract price, which can lead to a good low but also reflects unsettled tape.
Credit markets are shaky, with junk debt performing noticeably worse than Treasuries. Still not a cause for concern, but it demonstrates that there was not much of a cushion in spreads at recent tight levels.
Did defensive strategies work during the sell-off?
As a broad sell-off dragged down the major averages, the Dow Jones Industrial Average was on track for its worst day since last October. In afternoon trading, the Dow Jones Industrial Average’s 30 stocks were all down for the day.
However, strategists and professional investors have recently warned about the market’s over-reliance on a few large-cap stocks, as well as rising risks from Covid and inflation. Prime Capital Investment Advisors’ chief investment officer, Chris Osmond, stated on Monday that there were signs beneath the surface that stocks were due for a pullback.
“The market was building up to this, simply because of the narrowing breadth in the market that we’ve seen over the last few weeks. And you look at not only the breadth of the market, but also where we’ve seen growth in the market,” Osmond said, pointing to the recent strength in large cap tech.
Traditional defensive strategies were also gaining traction. In a note to clients, JC O’Hara, chief market at technician at MKM Partners, noted that defensive plays had outperformed in recent days.
“As market jitters began to rise in the second half of last week, the Low Volatility ETF, SPLV, set new highs. There was also some progress. “It is too early to ‘call’ this a relative trend change, but it has our tactical attention,” according to the MKM note.
The S&P 500 has fallen 0.6 percent in the last two weeks. Meanwhile, the Invesco S&P 500 Low Volatility ETF (SPLV) has increased by 1.8 percent, and the Utilities Sector SPDR Fund (XLU) has increased by 3.6 percent. Stocks in the health care sector have also outperformed, as some Wall Street analysts see it as a defensive play with strong near-term growth.
The utilities ETF’s largest stocks have mostly underperformed the market this year, but several have seen significant gains in the last two weeks. During that time period, Duke Energy increased by more than 5%, while NextEra increased by 4.9 percent.
In the low volatility index, notable moves in the last two weeks include Oracle’s 6.9 percent gain and Coca-4.1 Cola’s percent rise.
Both of these ETFs fell on Monday, but they have been outperforming the broader market in recent weeks.
Osmond, of Prime Capital, stated that he had recently added positions in Big Tech and that real estate investment trusts appeared appealing in this environment.
“Right now, REITs offer a very unique yield profile and superior yield creation relative to fixed income and other equity sectors. “You also get an inflationary hedge,” Osmond explained.
Over the last two weeks, the Vanguard Real Estate ETF, which tracks REITs, has also outperformed the broader market, rising 2.7 percent.
Portfolio Manager Mary Nicola advises
Global Multi-asset Portfolio Manager Mary Nicola said how she would allocate money over the next nine- to eighteen months to sail through stormy economic seas.
It comes as the threat posed by the Covid-19 pandemic resurfaces, with the delta variant of Covid causing a surge in cases worldwide.
Nicola explained that instead of focusing on rising Covid cases, PineBridge has been monitoring vaccination rates in various countries. She cited Singapore as an example of a location where the vaccine drive was significantly accelerated following the discovery of the new variant.
“So, as we see a recovery in us, as more and more countries kick off and accelerate that vaccine rollout, opportunities will open up for us,” Nicola said.
“Over the past few months… we’ve been essentially following the vaccine, where we started first in the United States and the United Kingdom, and we’ve moved into Europe, and now we’re going into Japan as well.”
She added that investment opportunities in Japan are likely, partly because of its status as a proxy for global growth, implying that it will benefit from the economic recovery, and partly because, as major economies such as the United States reach herd immunity, key allies such as Japan will likely benefit from increased “vaccine diplomacy.”
With vaccinations expected to rise sharply in the 10-member Association of Southeast Asian Nations region, PineBridge is focusing on Asian credit markets, which Nicola says offer compelling valuations and spreads.
“That’s where you can get real yields and an environment where yields are likely to stay low for longer, especially in the DM (developed markets) world,” she said, “even if we are seeing some pickup in terms of discussions about some tapering or any sort of hawkish tilt.”
“The fact remains that they will remain low for an extended period of time. Having said that, we believe that the majority of the attractive real-rate valuations will be in emerging markets, including Asia credit.”
Avoiding stock and industry calls
PineBridge has a significant allocation to mid-cap stocks in the United Kingdom, based on expectations for domestic growth recovery.
“After Brexit and concerns about Brexit were alleviated, we saw the United Kingdom moving forward with very supportive fiscal policy, very supportive monetary policy, and not only that, but they also had a key drive in terms of vaccinations,” Nicola said.
Rather than focusing on specific sectors or stocks, she emphasized how the overall asset class aligns with a recovery trajectory. PineBridge believes that UK midcap companies are best positioned to benefit from Britain’s domestic rebound in this case.
Morgan Stanley says it’s time to invest in the United Kingdom — and names its top picks.
Nomura selects two winning stocks in Japan, one of which is already up 122 percent.
According to the fund manager, there is a “better hedge” against rising inflation that is not gold.
Nicola said she looks at 80 asset classes and uses a “bottom-up” approach to assess the rate of risk and return over the next five years, rather than being “stock pickers.”
Notably, PineBridge’s Global Asset Allocation fund includes JPMorgan, as well as other U.S. banks and Microsoft.
Nicola attributed the holding of US financials to attractive valuations and the possibility of higher interest rates in the not-too-distant future.
“However, Microsoft’s allocation is mostly in U.S. cyclicals and the productivity basket, and again, that is more on the broader theme of tech and tech doing well in a post-Covid world,” she explained.