Terrible Day For The Small Caps
It seems like the market picks a random group of stocks to outperform each day with no reasoning behind it. There certainly isn’t a trend. On Friday, it picked the small caps to underperform; they had been doing well recently. Tech sector also was weak because Intel cratered after its earnings report.
Intel’s 16.2% decline makes sense, but the Russell 2000’s 1.52% decline is suprising. There are so many countervailing trends, it’s tough to keep track. This is the most unusual market most have ever seen.
Even though the headline indexes look fine, there’s a lot going on under the surface. Tech sector may have peaked, gold is near its record high, the dollar is crashing, and real yields hit a record low. Investors keep having to find stocks that do well in new environments.
Did Tesla Top?
With Friday’s decline, the CNN fear and greed index fell 5 points to 63. Nasdaq is down 3.8% since its peak and some tech investors are already starting to panic. That’s because stocks such as Tesla are down more. Tesla is 13.76% off its record high. It’s also because investors know these tech stocks have run too far which means they can decline a lot.
This is the big switch in speculators’ mentality that many have been waiting for. Traders are nervous, but they haven’t sold. If it becomes common knowledge that the top was reached, we could see a waterfall effect where the Nasdaq comes apart.
As you can see from the chart below, Tesla’s earnings estimates have risen, but they aren’t nearly as high as they were in March. On the other hand, the stock has exploded since then. Tesla had higher market share because electric car sales did well during the pandemic, but their sales were still down.
Most don’t see why electric cars will maintain their high share when the economy rebounds. Secondly, a higher share of a smaller pie isn’t a good thing, meaning if auto sales were to stay low it won’t be good for Tesla.
Secular Versus Cyclical
A lot of the stocks that are considered the winners in COVID-19 are over-owned. For example, Microsoft’s Azure had a decline in sales growth even though its stock is at a record high. This was a perfectly fine quarter, but I wouldn’t pay a premium for a stock that’s doing slightly worse because of COVID-19. Secondly, COVID-19 is a temporary factor. Investors are acting as if this will last forever.
Cyclical stocks haven’t rebounded nearly as much as tech. Airlines have recently been doing terribly as the JETS ETF is down 27.4% since June 8th. Boeing is down 24.6% since June 8th. Airline stocks were hyped by retail traders in the spring. Now they have been left for dead.
Maybe Buffett was right to sell the airlines. Robinhood investors haven’t sold out of American Airlines despite its drop. That makes sense since you wouldn’t want to sell it low. On the other hand, the airlines are facing debt problems again.
As you can see from the chart below, the ratio of secular to cyclical stocks increased from late March to early June. Since then, they have been pricing in a pause. Worst thing that can happen to the big internet stocks is an economic recovery because there would cause a sector rotation back to the cyclicals. Of course, we could also see all stocks decline like what occurred on Friday.
High-Low Index
As you can see from the chart below, for the first time in almost 30 years, the NYSE high-low index hit 100 as no stocks hit their low on the NYSE. There are 2,400 stocks listed on the NYSE. Previous record high was 99.6 in 2004.
That’s actually good news because stocks didn’t suddenly crash after that level was reached. This is a surprising threshold because we’ve seen poor breadth in the past couple months as the big internet stocks have led the indexes higher.
Buy Cheap Stocks
The table below shows that expensive stocks do worse in the worst 20% of economic environments. From 1929 to 2019, the top 20% most expensive stocks with a valuation multiple of 21.67, increased 1.01% in the next year. Bottom 20% of stocks with 10.49 PE multiples increased 40.61%.
It means value stocks do the best. This a weird table to look at because the most expensive stocks have been doing the best in the past 4 months. This time has been different because the high multiple stocks are the least impacted by COVID-19. A recovery would be bad for the secular growth names.
Dollar Is Crashing
As you can see from the chart below, the dollar index has fallen sharply recently. It’s down 1.67% in the past 5 days and 3.07% in the past month. It’s down 5.92% in the past 3 months. It peaked on March 20th. The dollar rallied in the 2nd half of the bear market as there was a flight to safety trade. And it peaked a trading session after stocks bottomed.
Dollar index really started to decline in late May. Currency traders realized America would be hit the hardest by COVID-19. The longer COVID-19 lasts, the longer ZIRP will last. Rates are unlikely to be raised in 2021 or 2022. Some investors have become more dovish because of the elongated weakness in the economy and the 2nd wave of COVID-19.
Conclusion
Investors have been focused on the relative performance of the big internet stocks and the rest of the market, but there are other trends under the surface. Gold is spiking; real yields and the dollar are falling. Macro picture is cloudy.
Tesla is as much of a macro play as it is an electric car stock. Bubbles occur in uncertain times masquerading as certain times. Gold and Tesla holders oddly both have intense confidence even though arguably they are calling for opposite things. Gold traders see uncertainty and Tesla traders see certainty.