Granted, the flattish indexes reflect a tired tape following an energetic thrashing this week and a decent near-3% three-day bounce in the Dow Jones. It puts the index roughly halfway between its peak on September 2 and its lows on Monday at midday. As the market is in a state of confusion, it is unlikely that the action has changed the minds of too many short-term bulls or bears.
The crucial action in Treasuries and subsequent rise in crude oil adds some fuel to the reflation trade, higher yields across the curve, a market pricing in possibly stickier inflation, and a Fed on track to begin the withdrawal process from its Covid stimulus efforts. The 10-year yield rose above this level in the spring, but 1.6 percent is regarded as a critical level, roughly the level from which yields fell as the Covid shutdown took effect.
Bank stocks are still benefiting from the yield boost, and energy is still on the rise, though there isn’t a rush to cyclicals or a flight from growth stocks.
a broader perspective: Coming into September, the Dow Jones had surpassed the +20 percent YTD gain level, with investors all-in on stocks and riding long winning streaks of monthly gains and time without a 5 percent pullback. Time and mean reversion have caught up with the indexes, and a reset is in the works to account for a mixed growth picture and policy inertia in a tougher seasonal period. The indexes, particularly the Nasdaq 100, became quite oversold as they approached the Monday low, and sentiment shifted from nice to fearful. Stocks have recovered nicely, but the recovery has stalled at “logical” levels, keeping everyone guessing.
Given the history of similar years, where we are in the cycle, and the pattern of how the first 5 percent pullback in a long time tends to play out, it remains unlikely that the Dow Jones would have peaked for the year on Sept. 2. Given the calm waters in the credit markets and the flush corporate coffers, this would imply that this is or will become a buyable correction in the end.
These are all trends, not guarantees, and it’s worth noting that when we say a late-summer market peak for a year (2015, most recently), it was when there was both a perceived global slowdown and a perceived rigid Fed trying to tighten.
The market is evenly split, and the equal-weight Russell 1000 is nearly flat.
VIX is slipping, as is typical of a slow tape. With a large data release already completed and ahead of a weekend. Under 19 for the first time in ten days, but still on the lookout for choppy action and seasonal shifts.
As we’ve been saying all week, we’re in the midst of a market reset that has priced in a third-quarter slowdown, reflected a flattening of earnings-forecast growth, and soured investor sentiment, all in a positive way. Another drop in retail-investor optimism was recorded in today’s AAII survey, which fell close to what has historically been considered a “contrarian buy” zone for stocks.
Since the end of the third quarter, economic surprise trends have improved (ISM services, claims, ADP, and so on). Have we reached a tipping point in terms of supply-chain friction and focus? Earnings calls may reveal whether the worst has been discounted on this front, but hints are beginning to emerge to that effect.
Things don’t always repeat so neatly, but the Dow Jones peaked on September 2, fell hard into late September, had a failed bounce, and then sank to flip-flop around its 100-day average before rebounding more convincingly with new cyclical leadership. This year, we peaked on September 2, fell for a few weeks, failed to rebound, and have been oscillating around the 100-day average as cyclical sectors percolate.
The market still needs to demonstrate that this is more than a reflex bounce; perhaps +2% to 3% from last night’s close would help make that case. Still facing tapering by central banks and retail investors attempting to digest massive increases in equity exposure resulting from the market’s ramp beginning in March 2020 and record stock inflows in the first eight months of 2021.
Here’s a look at the short-term tactical situation. Playing with the short-term downtrend and still hanging below where the index gapped down on Monday a week ago. Some fast-money traders will see this as a logical place to add more shorts. Market corrections/recoveries are a process, not a single event. Maybe this is the kind of neutral spot the market will be in heading into tomorrow’s payrolls report?
The banks are in an interesting spot here, with yields rising and the cyclical tone firming back toward the YTD highs, though JPM and BAC appear to be the best among the big ones, with more decisive breakouts.
Credit markets have remained firm; there has been no significant macroeconomic stress. Argues that this is more of an equity shakeout than a material increase in economic-recovery risk. For the time being, the dynamics of domestic and US reopening remain intact.
Market breadth is quite strong, with more than 80% upside volume.
The VIX is declining and beginning to make a decent spike on the chart, which could indicate that the fever is breaking, but at/above 20 indicates that there is no “all clear” message yet. Because of the jobs number directly ahead, it may be retaining some traction.
Energy looks attractive
“Energy offers attractive risk/reward with improving fundamentals, increasing capital return, and low market valuation,” the firm said.
With this in mind, the firm assembled two stock baskets: oil outperformers and oil underperformers. Each list contains high-conviction ideas that stand to win or lose if oil reaches and maintains a price above $100 per barrel.
The U.S. oil benchmark, West Texas Intermediate crude futures, traded around $77 per barrel on Thursday. Earlier this week, US oil surpassed $79 per barrel for the first time in nearly seven years. Brent crude oil fell on Thursday as well, but it remained above $80 for the first time in about three years.
This year, each contract has increased by more than 50% as demand recovers while supply remains constrained. Given the Dow Jones′s low exposure to goods-producing sectors, JPMorgan believes the market can support oil prices up to $130.
“We are seeing signs of supply stress across the energy complex after years of underinvestment due to low profitability and restrictive ESG policies,” the firm said.
Among the names in the oil outperformers basket are ConocoPhillips, Canadian Natural Resources, and Oneok. Each company on the list has a market capitalization greater than $1 billion. Names that are merger and acquisition targets or are difficult to shorten are excluded.
Other companies on the list include Cenovus Energy, Diamondback Energy, Continental Resources, and Marathon Oil.
The energy sector is up 44 percent year to date, and every component has registered a double-digit percentage gain for 2021. Nonetheless, the group is coming off years of underperformance as investors shied away from oil and gas stocks.
According to JPMorgan, the fundamentals of energy stocks are better today than they were between 2012 and 2014, when oil was around $100. The firm noted that the group generated profits of around $100 billion at the time, and that despite a lower oil price environment, the group could surpass that next year.
“Despite expense discipline and higher margins, Energy trades at a sharper discount to the market today,” according to JPMorgan. “In a world where most assets have been broadly rerated due to lower rates and liquidity, Energy continues to offer non-linear earnings growth potential for several years at an attractive valuation.”
While the firm believes the market can withstand oil prices as high as $130 per barrel, rising prices will have an impact on certain sectors. Companies directly related to discretionary spending are included, as are those that use energy as an input or feedstock, such as airlines and trucking companies.
Among the names on the firm’s “oil underperformers” list are 3M, Cummins, Pentair, United Parcel Service, FedEx, Newell Brands, Advance Auto Parts, Clorox, and Walmart.
Inflation and China
Analysts headed by Arend Kapteyn found in a Sept. 29 research paper titled “The Compendium – The 10 Toughest Questions We’ve Fielded” that government lockdowns enforced due to the Covid-19 epidemic currently have less of an impact on GDP growth than when the pandemic began.
“We find that a one point increase in mobility restrictions has squeezed GDP growth much less in the last few quarters… than a comparable rise in the first few quarters of the pandemic,” they said in response to the question, “Can mutant viruses derail the recovery?” When measures were less targeted, businesses had not yet adapted to increased online sales, and the impacts on supply chains were amplified.”
Can wages increase?
Stocks hit near all-time highs last month, and in response to the question, “How long will the profits upcycle persist?” experts indicated that certain sectors may continue to post stronger earnings until the beginning of next year. “Earnings momentum in Energy and Materials is expected to dissipate as quickly as it soared.” These sectors, like Industrials, may depreciate rapidly. “IT, Communication Services, Financials, and Consumer Discretionary would most likely contribute to prolong this profit growth through Q1 2022,” they said.
In terms of the reflation trade, in which investors bet on economic growth, the bank predicts that global growth will be about 8% for the remainder of the year before falling to 5% in the first half of 2022. In response to the question, “How much reflation space remains in this cycle?” According to the experts, labor market data is “later cycle” than would be expected. “The major surprise here is that Europe has now recovered more lost labor from the epidemic than the United States.” The bank also said that profits would “surprise on the upside” in the next three to six months.
The China issue
China’s new “shared prosperity” program seeks to promote modest affluence for everyone, and the nation is expected to tighten regulation and credit. The government has already clamped down on IT firms, wiping billions from the industry in recent months.
While regulation impacts growth stocks in China — assets such as technology that investors anticipate to outperform the broader market — it also hurts value stocks worldwide, or those shares that are seen to be selling at lower values.
In response to the question, “What does China’s Common Prosperity imply for markets?” “We think the new regulatory reality may be priced into Chinese equities soon,” the analysts wrote, adding that “the effect of slower credit growth in China over the medium term is not completely priced in global assets.”
What about supply chain management?
During the epidemic, a shift in consumer spending from service-led companies such as restaurants to commodities like as home furnishings created a “trade imbalance” that resulted in container shortages in Asia, where some of those items are produced, according to the experts.
Semiconductor chips, which are used in everything from automobiles to cellphones, have also been in short supply. In response to the question, “Are supply constraints easing?” According to the researchers, “when vaccine roll-out now allows economies to reopen, spending should begin to shift back to services, relieving pressure on global commerce.”
Inflation, liquidity, and the fiscal cliff are all factors to consider.
When asked, “Is transitory inflation turning into permanent inflation?” According to the experts, most of the present inflation will “dissipate.” “The surprise has been in goods that were already suffering high inflation last year having even higher inflation this year,” the experts said, citing food as an example. “Only a tiny portion of the increase in inflation is expected to be permanent, and when supply and demand return to pre-pandemic levels… inflation is likely to decrease,” they said.
Morgan Stanley has revealed its best dividend equities in Asia.
Credit Suisse has released six new top stock picks for October.
According to JPMorgan, these are the stocks to buy — and sell — if oil reaches $100.
UBS stated that “all major central banks [are] anticipated to be reducing, or even stopping, asset purchases by the turn of the year” in terms of liquidity in the market, as central banks have given fiscal stimulus from the onset of the epidemic. The European Central Bank, for example, reduced its bond purchases in September, but it said that this was a rebalancing rather than a reduction. In response to the question, “What is the prognosis for liquidity, and what does that imply for markets?” the experts stated, “‘Growth’ may continue to drive the market for a bit longer, even while liquidity runs out.” However, when earnings growth ebbs, most likely in Q1 ’22, anticipate a noticeable downshift in returns.”
In response to the question, “Can the fiscal cliff next year derail the recovery?” UBS said that the fiscal cliff is “primarily a US issue” and that the cliff “may well vanish.” “Delayed stimulus expenditure” by consumers (drawdowns of surplus savings) may offer a significant counterbalance to fiscal pressure in 2022, according to the bank.
Monetary policy and fiscal imbalances
For a long time, the United States has had so-called twin deficits, which means that its current account and fiscal accounts are both spending more than they are bringing in. The current account relates to international transactions — thus the United States is presently spending more on imports than it is making on exports — while the fiscal account refers to domestic expenditure on large projects like infrastructure. “There is a history of delays between twin deficits peaking and the dollar’s performance,” the experts said in response to the question, “Has the dollar troughed if twin deficits and the cycle have peaked?” We continue to be negative on the dollar versus G10 currencies.”
Investors also inquired about whether the “neutral rate” had risen or fallen, referring to the natural interest rate that exists when inflation and the economy are steady. The Federal Reserve uses it to make monetary policy choices, and according to UBS, the neutral rate will fall from 2.5 percent pre-pandemic to 1.7 percent by the end of 2023. As a result, the bank predicted that the Fed would “keep rates reasonably low” – it has kept interest rates around zero.