“We continue to believe that there will be another leg lower in sectors that have displayed bubble-like behavior since the onset of the COVID-19 pandemic,” JPMorgan’s chief global markets strategist, Marko Kolanovic, said in a note Thursday.
“These include COVID-19 lockdown stocks, renewable energy and EVs, crypto, hyper-growth, and innovation stocks. While these segments saw a significant correction earlier this year, we believe there will be another leg lower,” Kolanovic said.
Stocks linked to the stay-at-home trend, such as Zoom Video and Peloton, retreated from last year’s massive rallies as the pandemic’s boost began to fade amid the reopening. Meanwhile, industries such as clean energy and electric vehicles had a record-breaking 2020 due to increased investor interest. The Invesco Solar ETF gained more than 230 percent last year and is down 17 percent this year.
Kolanovic believes that more weakness for these sectors is on the way as sky-high prices continue to fall.
The strategist was one of the few Wall Street analysts who correctly predicted the March bottom and subsequent rebound. He holds a Ph.D. in theoretical physics and is well-known on Wall Street for using alternative and quantitative data to forecast the ups and downs of the stock market.
“The final level of correction will most likely be determined by valuation convergence between these and equivalent traditional sectors,” he said.
On the bullish side, the strategist believes bond yields bottomed out last week, implying a rebound in shares sensitive to an economic recovery.
Last week, the 10-year Treasury yield fell to 1.15 percent as investors fled to safe haven bonds in response to rising concerns about the coronavirus delta variant. Since then, the benchmark rate has risen to around 1.36 percent as of Thursday. Prices and yields move in opposite directions.
“We believe bond yields and cyclicals bottomed last week and are now on an uptrend for the rest of the year,” Kolanovic said. “While we believe bond yields will rise significantly, we believe the risk of a broad market sell-off caused by tech-bond correlation is low and manageable. Another reason we favor cyclicals, international stocks, and value.”
Low summer volumes
The market is spinning its wheels a little at the highs, but so far there has been no backsliding. While approaching some upside technical targets, some of which converge between here and 4500, the S&P index is floating on opposing currents (tech pullback vs. cyclical bounce in recent days, the opposite today).
-Low summer volumes mean a lack of strong “real money” flows, leaving the daily action to tactical players and dealers hedging options exposures. The S&P is being restrained in its intraday moves, with each close this week coming within a whisper of where it opened:
This is accomplished in part by the constant sector seesaw action. Here’s an intraday comparison of the Nasdaq 100 and the KBW Bank index:
Again, this interplay can occur when overall market conditions are stable and there are no shocks from macro inputs. The relationships can and will change or be overwhelmed by a broader market impulse at some point, but for the time being, this is where we are.
-Some wiggle room in the “back to cyclicals” trade, which has been in place since before the jobs report and is supported by virtually every strategist and buyside voice. Asia is slowing due to rising caseloads, and there is some softening in US credit-card spending indicators in the air. It’s not a significant change; it’s just noise.
-Semis has backed off, and the group’s recent upside breakout is now being called into question. Downgrades, resumption of supply, and operational concerns in Asia are dampening enthusiasm.
PPI data is definitely hot, and while it isn’t a huge market catalyst, it will keep investors on the lookout for profit-margin resilience and pricing power. The market has already rewarded companies that meet these criteria while punishing those that do not (for example, in food/household goods and restaurants). There are still several months until we have a firm grasp on the inflation trajectory and, by extension, the Fed’s outlook.
-Disney shares have cooled significantly but remain stable, with pandemic excitement over Disney+ receding, enthusiasm for park reopening leverage possibly priced in, and the stock still trading at a premium valuation. It’s amusing that, despite all the Covid/streaming hype, the stock has tracked well with another media mega-cap that doesn’t have a Magic Kingdom or a comic-book-character multiverse.
Today’s market breadth was soft once more, and it’s been pretty ragged beneath the surface. This can go on for a long time, even if it eventually leads to more visible market weakness. It is assisting in keeping investor sentiment relatively muted/defensive, which is a positive.
-VIX is being weighed down by the lack of intraday movement and late-summer sluggishness. Now in the 15s, it probably should be, but more traders are pointing out that it makes protection against any late-August market turbulence appear relatively cheap.
It comes as market participants remain concerned about the implications of reaching peak economic growth, following moves to relax public health measures in the midst of the ongoing coronavirus pandemic.
Some on Wall Street are concerned that peak growth in both the economy and corporate earnings, which has been fueled in part by a stimulus-fueled recovery, will soon give way to more normalized patterns.
“This tremendous acceleration that we have seen over the last 15 months has really generated one of the all-time great equity market bull runs,” Sebastian Raedler, Bank of America’s head of European equity strategy, said Geoff Cutmore on Wednesday.
However, Raedler stated that BofA recently downgraded European stocks from positive to neutral, citing an expected slowdown in growth momentum for the remainder of the year.
“We have a 10% downside into the end of the year, but we believe that downside will only materialize once the real slowdown begins, which we believe will only happen in the fourth quarter,” Raedler said.
“It helps to understand how we got here and how things are going to change,” Raedler said, mentioning two risk factors for investors to keep an eye on in addition to fading growth momentum.
“So, two very significant events occurred last year. First and foremost, the growth rate accelerated dramatically… but equity multiples also benefited greatly from a drop in the discount rate because real bond yields, which serve as the discount rate for equities, fell as central banks became increasingly dovish.”
A discount rate is a metric used by traders to calculate the cost of financing activity for a business.
This “goldilocks environment” of higher growth rates and lower discount rates, according to Raedler, is a “fantastic sugar rush” for equities. BofA now sees room for higher discount rates and lower growth rates.
“So, we believe you’re almost from here, in an anti-goldilocks environment. Instead of stronger growth and a lower discount rate, the next six to nine months are likely to see slower growth and higher discount rates. And, obviously, that sounds like an unappealing proposition.”
According to the bank, the utilities sector’s 20% underperformance since last March has left its price relative at a two-year low, and its Purchasing Managers’ Index projections imply only a 5% further decline.
According to BofA, it is overweight on European assets that will benefit from a final leg of rate rises, such as financials and value versus growth, and underweight on bond-proxy sectors such as health care and staples.