As we kick off the second quarter, the primary question we must grapple with is whether the rotational action that has recently dominated the market will continue. This very choppy action was the product of two issues -- higher interest rates and anticipation of the economy's reopening.
Ironically the biggest obstacle for the market of late has been fears of too much growth and too much stimulus. While there is still some pessimism about how quickly the COVID crisis may wind down, the more significant concern is that the combination of growth and stimulus will push up interest rates and cause worries about inflation.
Fed Chair Jerome Powell has assured us that inflation is likely to be transitory as the economy quickly ramps back up, but this is not the sort of issue that the market handles very smoothly.
An additional issue this past quarter has been that many speculative areas of the market had overheated and were overdue for corrective action. Much of this was driven by small traders that ramped up speculative "junk" like GameStop (GME) , but it also impacted sectors such as SPACs, cannabis, electric vehicles, gambling, and biotechnology.
The ARK ETFs are a good illustration of what happened to many of the leading stocks during the past quarter. The ARK Innovation ETF (ARKK) fell from around $160 to $110 during the quarter, which is a drop of over 30% and a technical bear market. ARK was not alone. Many other areas of the market also suffered bear market corrections, although it was well hidden by the rest of the market.
This disconnect between the indices and the speculative favorites will be a crucial issue as we move forward. Will the high-growth and small-cap speculative names come roaring back, or will the indices lag and close the gap between the two groups? A significant rotation has already occurred, and now we have to see if it continues or starts to reverse again.
There is no way to know what lies ahead, but I will be watching closely for a return to better stock-picking. In the second half of the first quarter, stock-picking suddenly stopped working well, as macro issues and rotation became the dominant themes. Over the last couple of days, we have seen a return to better stock-picking. With first-quarter earnings coming soon, there is a good chance it may be sustained to some degree.
We have a slightly positive start and better sentiment after the bounce in technology and small-cap names on Wednesday.
Don't forget that the market is closed on Friday for the Good Friday holiday.