It seems the summer frenzy, with the S&P 500 rallying 8% in August alone, then unwinding entirely in September, has left investors sitting on the sidelines waiting to get past the November election and winter Covid-19 uncertainty before stepping back into the market. Sentiment and trading indicators that seemed super-overbought have now unwound to more neutral levels, especially the extreme long positioning in the market and technology sector. The question on everyone's mind is, "Is this it or can the market fall much more?"
This has been one of the most loved and hated bull and bear market rallies. One thing is certain: Bull markets never end with such hated conviction or neutral positioning. This year most not only have been surprised by the extent of the post-Covid market damage, but also by the speed of the recovery back to highs. Then again, central bank liquidity has been unprecedented; they pulled out all the stops to fight this selloff and boost the market as much as possible.
It is debatable whether their measures actually reflated the economy, other than just inflate asset prices. Anyone who says the stock market is not the economy should speak to the Federal Reserve, as it clearly hopes the stock market is the economy as that is the only way it knows how to stimulate it.
The past decade clearly has taught Fed officials nothing, but now they are victims of their own practice. The only way they can boost the consumer is to boost their net asset value, hoping it will result in them spending more. But now after the initial lockdown boost, the global economy is showing signs of stalling as global trade and volumes and jobs have still not recovered to pre-Covid levels. The Fed has kept its balance sheet stable for the past four months, but the market is a beast that needs to be constantly fed with liquidity in order to move higher.
After a $3 trillion injection in a few months, the Fed has now passed the baton to the fiscal heads as fiscal stimulus is the only thing that can help salvage this recession and get the economy going again. We are now in the period of vacuum where investors are waiting for a fiscal package to be passed, but Democrats and Republicans only care about who has the political advantage, not really about saving the economy. For now, we are stuck in their games where the average Joe is left wondering when his job is coming back.
The leaders of this market have been technology (growth) versus the likes of financial, energy, materials and other economically sensitive sectors (value). Growth has outperformed value by 45% in just 12 months and most are wondering when to time the turn. They have tried again and again, to their detriment. Unfortunately, until there is an actual earnings and economic recovery, the value sector will stay weak and underperform. For the market to make new highs, all sectors need to rally as we say on Monday, when financials were up on the day, too, not just technology.
After September's wobble, most are wondering if this is the pre-1999 boom or the post-2000 collapse. Everyone is sitting there watching their charts hoping to catch the next 7% dip in the S&P 500 down to the 200-day moving average around 3100. Hedge funds have de-geared their risks and certainly their technology longs after the extreme August highs. Given all the risk uncertainty around elections, the thing that will surprise investors most is a slow and painful grind higher in markets, as they are not positioned for it.
Sod's law suggests that if everyone wants to buy their favorite stocks 5% to 10% lower from here, the pain trade will be stocks slowly rising, forcing market participants to chase them even higher. Amid the broader macro uncertainty and a mild washout, pick your stocks with conviction on their earnings and fundamentals. It is best not to be too cute in waiting for another dip, for even if it does happen, would you not want to add more to your conviction ideas?