Financial markets had shown to this point an incredible immunity to the spread of coronavirus that causes Covid-19. Maybe immunity is the wrong word. Maybe one way to better put it would be to say that markets could be resilient in the face of this coronavirus as long as markets believed that policy makers had their backs and that the loss of organic income across nearly all levels of the economy would be temporary, as in short to medium/short-term. The mere fact that the major large cap indices had reached or approached levels that they have since the February/March sell-off has been remarkable. The Nasdaq Composite bottomed on March 23rd, and traded at an all-time record high on June 23rd. Three months of glory for investors, as long as they were otherwise healthy. The S&P 500 saddled down by a broader membership has not experienced as robust a recovery as has the Nasdaq Composite, peaking on June 8th, roughly 160 pts, or almost 5% short of equaling the mid-February peak.
While most of us study economics as a numerical expression of human response to conditions ranging from surplus through scarcity regardless of the source of this condition, be it authentic or artificial. Truth be told, the actual source of these underlying economic conditions is almost always some mix of the authentic under the influence of the artificial. This is why most of us had expected a halt to the advance maybe half way up as the economy rebounded. The economy is now running into a series of factors that are cause for concern that there will be a stalling. The markets had already priced in an overly aggressive rebound. Then calamity struck. Some regional economies reopened too quickly. Social unrest, often without concern for viral spread, moved across American cities. Irresponsible behavior by overconfident individuals just about everywhere, from all walks of life. All are factors in the rapid spread of a virus in areas that maybe had thought to have been spared the misery of this public health crisis. As it becomes obvious that the economy will not recover quite as quickly as previously hoped for, does an S&P 500 that even after a very rough Friday, or a very rough week, that closed that week below its own 200 day SMA, finally appear expensive? At 21.7 times next 12 months earnings?
I will tell you this. Nobody I talk to is talking much about Q2 earnings. In fact, Q3 is not even the topic of conversation. That said, the market largely believes in not just earnings growth, but large cap revenue growth for calendar year 2021. Does this belief evolve in the way planned as infections force slower or even reversed reopenings of economies? Does this belief evolve in the way planned if faith in the policymakers' ability to continue to bridge gaps in capital flows really fades? Does this belief evolve in the way planned if during an election year, the public loses faith in both the incumbent as well as the challenger? Nothing has to evolve in a worst case scenario but each and every worst case is a risk, and risk has not been properly assessed due to what is referred to above as the mix between underlying authentic and artificial conditions. The more that reliance is forced upon the artificial, and less upon the authentic, the more the investor must understand and accept an increased public tolerance for volatility. There is no other way at this juncture to get from point A to point B.
Mirror, Mirror On The Wall
Is this market now set to fall? As just demonstrated, the Nasdaq Composite has now traded sideways to lower for just three sessions, however for the far more lethargic S&P 500, there has been more "lower" than "sideways" of late and that the three days is more like three weeks. I don't think it should surprise anyone who pays attention that as measured by Select Sector SPDR ETFs that Information Technology (XLK) is your leader over the past week, past month, past quarter, year to date, or past 12 months. Tech, whether you want to believe it or not, represents both the growth crowd, and the defensive crowd despite the inconsistency in such investor amenities as high dividends favored by this type of investor in the past.
This creates a different kind of problem. As there can be no doubt that we have over recent weeks seen a number of high volume "down" days for U.S. equity markets, traders must come to terms with the undeniable truth that we are now and have been witness to professional selling. Some of this has been forced due to scheduled quarterly index reweighting. Some of this will continue to play out this week as various pension and mutual funds with allocation mandates are by rule forced to reweight equities versus debt securities. There may have been a bit of this already put to the tape on Friday for some managers who might have more discretion in the terms of the execution of their responsibilities than others. The rest must wait for Tuesday afternoon to play ball. If the other side does not step up, then most sell-side projections are sizing up a pretty large aggregate sell ticket (estimated between $35 billion and $75 billion).
That said, I can not yet call the end of the current uptrend, though I will not need much convincing for the S&P 500. There is no doubt that even beyond Energy (XLE) , that the Financials (XLF) and Industrials (XLI) face challenged futures. Now, think about this... where would Communication Services (XLC) be without the internet stocks? Facebook's (FB) current situation forces that particular question. Where is Health Care (XLV) without Biotech? Big Pharma has largely been unable to carry the football of late.
One has to imagine that though the supportive efforts of policy makers has gone beyond expectations that should the economy hit or remain at stall speed for very long that even in a low interest rate environment, even with the Fed buying corporate debt, and even with what smells to the ordinary observer as the very beginnings of the implementation of both "Yield Curve Control" as well as "Modern Monetary Theory", that even though these inputs do keep large cap listed companies afloat, and produce some helicopter money for the masses, they can not prevent short- to medium-term defaults across small to medium-sized "Business USA" ... and that will further pressure labor markets unless somehow corralled. If markets sniff this out, we have seen the highs.
Now, about the election. The challenger, former Vice President Joe Biden, does not scare the moderate right the way some of the other candidates on the left might have. That said, higher taxes and increased regulation certainly do. The election is not yet priced in, but most certainly is on the radar. If the incumbent does not start closing the gap soon, markets will create their own.
One more point. Small investors. Participation has increased as individuals were pushed to the sidelines either due to lack of available work, or the newfound ability to work from home. Some of these folks have no longer-term experience and may only have personally experienced the recent market rebound. We all know how terrifying it is for the new investor or the new trader when they get hit by the "ugly stick" for the first time. We, as a nation, risk losing an entire generation of investors if the next five or six months do not at least appear to pass in organized fashion. What does that do to a nation that does historically understand business very well, but can not sing or dance?
All these threats are real. Then again, this is 2020, and it is true that everything has changed. Yes, many funds will rebalance this week, this shortened holiday week. Numbers will pour in from states currently under siege from this horrible virus. That said, this is also "Jobs Week" for June. Before we even get there, both Fed Chair Jerome Powell and Treasury Secretary Steven Mnuchin testify before the House Financial Services Committee Tuesday afternoon.
Ahead Of Jobs Day
Traders may try to take advantage of a potentially volatile and perhaps light trading volume week by focusing on Tesla's (TSLA) likely announced number for second quarter deliveries probably set for either Wednesday or Thursday. The street is looking for roughly 85K vehicles. That said, there is far more for Tesla to address, and who knows how much will be said. Last Friday brought forth the announcement by Amazon (AMZN) that the firm had agreed to acquire Zoox, a privately held operation working toward a ride hailing service that would feature autonomous vehicles.
The focus will also be Chinese demand for Tesla products, not just because they have to compete with NIO (NIO) , but also because a third competitor for that market, Xpeng just started delivering its P7 sedan this weekend. This story will gain interest as the week evolves.
Economics (All Times Eastern)
10:00 - Pending Home Sales (May): Expecting 15.2% m/m, Last -21.8% m/m.
10:30 - Dallas Fed Manufacturing Index (June): Expecting -26, Last -49.2.
The Fed (All Times Eastern)
11:00 - Speaker: San Francisco Fed Pres. Mary Daly.
15:00 - Speaker: New York Fed Pres. John Williams.
Today's Earnings Highlights (Consensus EPS Expectations)