Is Risk-Off Starting to Creep In on Wall Street?
U.S. stocks fell on Friday, pushing the Dow Jones Industrials Average into the red for the week, as inflation fears overshadowed strong retail sales numbers and better-than-expected earnings reports.
The Dow lost 299.17 points, or 0.86%, to close at 34,687.85. The S&P 500 dipped 0.75% to 4,327.16 and the Nasdaq Composite shed 0.8% to 14,427.24.
The three averages closed the week lower to each snap 3-week win streaks. The Dow ended the week down 0.52%, while the S&P 500 dipped 0.97% and the Nasdaq Composite fell 1.87% during the same period.
A U.S. consumer sentiment index from the University of Michigan came in at 80.8 for the first half of July, down from 85.5 last month and worse than estimates from economists, who projected an increase. The report released Friday showed inflation expectations rising, with consumers believing prices will increase 4.8% in the next year, the highest level since August 2008.
The Dow gave up its gains early Friday shortly after the University of Michigan report came out 30 minutes into the session. Losses increased as the day went on with major averages closing at the lows of the session.
The consumer sentiment weakness “is at face value hard to square with the acceleration in employment growth and the continued resilience of the stock market,” said Andrew Hunter, senior U.S. economist at Capital Economics, but the report “suggested that concerns over surging inflation are now outweighing those positive trends.”
Inflation fears
The market was held back all week by inflation fears although the S&P 500 and Dow did touch new all-time highs briefly. On Tuesday, the consumer price index showed a 5.4% increase in June from a year ago, the fastest pace in nearly 13 years.
Stocks got off to a good start Friday with the Dow rising more than 100 points to above 35,000 shortly after the open. Data released before the bell showed retail and food service sales rose 0.6% in June, while economists surveyed by Dow Jones had expected a 0.4% decline. If that level held, it would have been the Dow’s first close ever above 35,000.
Despite the week’s losses, the Dow is still up 13% for the year and sits just 1.15% from an all-time high. The S&P 500 is up 15% on the year and is 1.51% below its record level.
“The market looks broadly fairly valued to me, with most stocks priced to provide a market rate of return plus or minus a few percent,” Bill Miller, chairman and chief investment officer of Miller Value Partners, said in an investor letter.
“There are pockets of what look like appreciable over-valuation and pockets of significant undervaluation in the US market, in my opinion. We can find plenty of names to fill our portfolios and so remain fully invested,” the value investor added.
Energy correction
Energy stocks, the hottest part of the market in 2021, fell into correction territory on Friday as oil prices pulled back from their highs.
The Energy Select Sector SPDR Fund fell more than 2% on Friday, the worst of any group, dropping 14% from its high. Still, the sector is up about 28% in 2021, making it the top performer of any of the 11 main industry groups.
Weaker performance from technology stocks also weighed on the market Friday. Shares of Apple closed 1.4% lower after notching a record close just two days prior. Netflix shares fell ahead of the streaming giant’s second-quarter earnings report next week.
Investors digested strong earnings results from the first major week of second-quarter reports. Though some of the nation’s largest companies posted healthy earnings and revenues amid the economic recovery, the reaction in the stock market has so far been muted.
The Financial Select Sector SPDR Fund ended the week 1.5% lower despite big profit growth numbers posted by the likes of JPMorgan Chase and Bank of America.
“Good earnings might have become an excuse for some investors to take profit. And with earnings expectations so high in general, it takes a really big beat for a company to impress,” JJ Kinahan, TD Ameritrade chief market strategist, said.
Devik Jain and Shreyashi Sanyal of Reuters also report Wall Street edges lower as value, growth stocks fall; defensives gain:
Wall Street's main indexes fell on Friday, with growth and value stocks falling as investors turned risk-averse towards the end of the week, while gains in defensive parts of the market kept declines at bay.
Markets have largely cheered a steady recovery in the labor market this year, but concerns about higher inflation due to a faster-than-expected rebound has hurt sentiment, with investors oscillating between "value" and tech-heavy "growth" names in the past few sessions.
Economy-sensitive S&P 500 energy (XLE), financials (XLF) and industrials (XLI) led declines among the 11 major sector indexes by afternoon trading. The energy sector is down over 6% so far for the week.
Technology stocks (XLK) also fell on Friday, while defensive utilities (XLU), consumer staples (XLP) and real estate (XLRE) gained. Real estate also hit a record.
"It's been hard for the market to gain here from these already elevated prices," said Rick Meckler, partner at Cherry Lane Investments in New Vernon, New Jersey.
"Investors are more concerned right now about missing the upside of this market than they are about a sell-off. In the near term, all they're really doing is shifting between stocks and not taking money out of the overall market."
Data from the Commerce Department showed retail sales rebounded 0.6% last month, as spending is shifting back to services, bolstering expectations that economic growth accelerated in the second quarter.
After earnings from big banks this week, focus will shift to quarterly results from technology-focused companies including International Business Machines Corp (IBM), Netflix Inc (NFLX), Verizon Communications (VZ), AT&T (T), Intel Corp (INTC), Snap Inc (SNAP) and Twitter Inc (TWTR)."We got a lot of optimism for the earnings, but then you've got fear of inflation and that's kind of giving us a whipsaw market," said Dennis Dick, a proprietary trader at Bright Trading LLC.
"The tech earnings starting next week can make the market forget about those fears (inflation)."
At 12:18 p.m. ET, the Dow Jones Industrial Average (DJI) was down 56.65 points, or 0.16%, at 34,930.37, the S&P 500 (SPY) was down 4.83 points, or 0.11%, at 4,355.20 and the Nasdaq Composite (NDX) was down 12.88 points, or 0.09%, at 14,530.25.
Moderna Inc (MRNA) jumped 7.9% to scale new highs after S&P Dow Jones Indices said the drugmaker will join the S&P 500 index as of the start of trading on July 21, replacing Alexion Pharmaceuticals (ALXN).
Cintas Corp (CTAS) rose 3.8% to the top of the S&P 500 index after brokerages raised their price targets on the business service provider's stock following its fourth-quarter results.
Didi Global Inc (DIDI) fell 3.4% as China sent state officials from at least seven departments to the ride-hailing giant for a cybersecurity review.
Declining issues outnumbered advancers for a 1.18-to-1 ratio on the NYSE and a 1.02-to-1 ratio on the Nasdaq.
The S&P index recorded 47 new 52-week highs and no new low, while the Nasdaq recorded 37 new highs and 77 new lows.
It was another interesting week in markets where investors were on edge over rising inflation pressures and lower bond yields.
Normally, when inflation pressures rise, long bond yields rise as investors worry that inflation will erode the real value of a bond's face value.
But the yield on the 10-year Treasury note kept declining this week as investors grapple with rising delta variant cases and slower international growth:
As shown above, this ETF is just hovering above its 200-day moving average but it remains to be seen whether long bond prices will continue to rally (as yields decline further) or whether the latest rally is due for a pullback.
One fixed income portfolio manager told me they're shorting Treasuries here after a nice rally.
In any case, bond yields matter for sector positioning in the stock market.
As shown below, the best-performing sectors this week were defensive/ interest rate sensitive sectors like Utilities (XLU), Staples (XLP) and Real Estate (XLRE) whereas the worst-performing sectors were once again cyclicals like Energy (XLE), Materials (XME), Financials (XLF) and Industrials (XLI):
Tech stocks (XLK) and Consumer Discretionary stocks (XLY) which are made up of Amazon and Tesla (a third of the ETF) also struggled this week, indicating RISK-OFF sentiment reigned.
So what should we expect going forward? Francois Trahan of Trahan Macro Research notes the valuation gap between growth and value is at extremes, reminiscent of the 1999-2000 tech bubble, and when that unwound "value went on to outperform for almost a decade":
He's not the only one worried about tech bubbles and extreme valuation gaps.
In his weekly market wrap-up, Commodities > Growth, Martin Roberge of Canaccord Genuity writes:
This week we are revisiting a key investment dilemma: should investors heed the message from commodities or from the bond market? This is an important issue because if falling bond yields are signalling a marked growth slowdown, the rotation into growth stocks is legitimate. However, if strongly rising commodity prices signal that growth will temporarily slow before re-accelerating, the rotation into growth stocks is at risk. We lean toward the latter scenario but more so for the hyper-growth or high-multiple stocks. In fact, our Chart of the Week shows that the performance of these companies as measured by the ARK innovation ETF looks eerily like that of the NASDAQ through the 2000 calendar year. Back then, commodities were strong and validated a tighter Fed policy. After a first leg down in March-April, the NASDAQ rebounded briefly through the summer, and then lackluster corporate guidance in the fall fuelled a >40% collapse. Fast-forward to today and commodities like in 2000 are signalling not the need for a tighter Fed but a less accommodative one. This is a subtle difference but a similar policy direction. Bond yields went down throughout the 2000 calendar year and did not support growth stocks. We believe the lower bond yields today represent a similar pitfall for hyper-growth/high-multiple stocks. Thus, unless forward corporate guidance comes in much above expectations, odds are that the bear market in this group of stocks is likely not over yet.
Interestingly, the ARK Innovation ETF (ARKK) managed by Cathie Wood has gotten hit lately after a nice rally off the May lows and is resting on its 50-day moving average:
Will these hyper-growth stocks continue to lose steam? It's very likely, especially if sentiment turns more bearish, but there's still plenty of liquidity out there.
Still, a lot of the meme stocks I'm tracking are getting whacked hard recently so it's possible that leveraged funds are de-risking here:
The only reason I track these meme stocks is to track the risk appetite of large quant funds that are behind the pumping and dumping of these stocks.
It is very possible that investors are starting to worry that the Fed is behind the inflation curve and this is why you're seeing risk-taking activity curbed in recent weeks:
Bond markets are sending an ominous signal to a Fed that seems to be determined to keep monetary policy easy in the near term. The gap between 10-year and 2-year yields has shrunk to the least since February. The real 10-year yield is also the most negative since then. pic.twitter.com/XVdE111761
— Lisa Abramowicz (@lisaabramowicz1) July 15, 2021
If for any reason the market feels the Fed is behind the inflation curve, it will hit hyper-growth stocks very hard.
If however the global economy keeps slowing, inflation fears will eventually subside and you'll see rates continue to stay low. This will support tech shares.
It's a bit tricky here, lots of cyclical inflation pressures but the Fed so far continues to toe the same line.
We shall see if this remains the case for the rest of the year.
Below, Big Tech stock earnings are coming down the pike in the next few weeks, Jon Nagarian says, but retail is doing well. Watch his analysis on CNBC's Halftime Report.
Also, Stephanie Link, Chief Investment Strategist and Portfolio Manager at Hightower, and a CNBC Contributor, joins Worldwide Exchange to discuss her market outlook.
Lastly, Doubleline CEO Jeffrey Gundlach discusses inflation and whether he thinks it's transitory or will grow to be more insidious for the economy. He also discusses why pensions are likely to be buyers of long dated Treasuries once they achieve a higher funded status.
Gundlach also weighs in on stock valuations, which he believes are extremely high but "still cheap to bonds". He believes the Fed and stimulus are supporting stocks right now through QE.
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