Before The Bell
The month of September, which draws to a close today, has certainly lived up to its reputation as being an unpredictable one for the U.S. equity market. Indeed, the daily volatility has picked up notably after a tranquil start to the 30-day stretch. The last fortnight of trading has produced some swift—and at times pronounced—swings in trading, including sizable selloffs both this week and last. The first was prompted by debt concerns in China’s highly leveraged property market, while this week’s setback was driven by the recent spike in Treasury yields on inflation concerns and Federal Reserve commentary. However, this morning the futures are positive, indicating some bargain hunting at the start of trading, as news broke overnight that the Senate reached a deal to avoid a government shutdown. Other Washington uncertainties remain, namely the debt ceiling and the fate of the big spending bills pending in Congress.
The main driver of trading this week has been the aforementioned spike in Treasury market yields. The coupon on 10-year Treasury note, which sat in the 1.30% vicinity for an extended stretch, jumped late last week and the upward movement has continued this week; the yield has held above the 1.50% mark the last few days.
Yields did not change after the Labor Department reported that initial weekly jobless claims came in at a weaker-than-expected 362,000 during the latest week, and as mentioned futures were in the green. The central bank’s raised inflation forecast for this year and commentary from Federal Reserve leaders following the latest FOMC meeting that the lead bank may begin to taper its bond-buying program before the year end of this year, have pushed bond yields higher. Accordingly we have seen more of the so-called “inflation trade,” meaning significant sector rotation in the last few trading sessions, such as in and out of the technology names, energy, and other economically sensitive industries, along with the possibility of some window dressing by fund managers, adding wish-they-held names to their portfolios on the final trading day of the third quarter, may give stocks a boost during today’s session.
Signs that the economy is still expanding at a healthy pace (the final revision to second-quarter GDP estimate from the Commerce Department this morning was from 6.6% to 6.7%), have raised bond yields and lifted stock prices in the energy, materials, and financial sectors. Our sense is that the value stocks in the cyclical sectors and those that are seen as inflation-trade issues will continue to garner Wall Street’s attention in the coming weeks.
Meantime, it has been a difficult stretch for the technology sector. The jump in bond yields has pressured the high-growth stocks in recent sessions, many of which entered September with rich valuations. Shares of the FAANG stocks and fellow mega-cap Microsoft (MSFT) have been under selling pressure, along with the work-from-home, shop from home technology companies that did well during the height of the coronavirus pandemic. In particular, the stocks of Zoom Video Communications (ZM) and Square (SQ) have been hurt in the wake of prospects of higher borrowing costs, as well as the continued reopening of the U.S. economy. The recent divergent stock performance charts of Microsoft versus JPMorgan Chase (JPM) highlight the sector rotation on display on Wall Street.
In view of the volatility, we think investors would be best served by looking at the stocks ranked 1 (Highest) or 2 (Above Average) for Safety by Value Line. These high- and good-quality issues have historically fared better than the broader market during uncertain times. The “wall of worry” remains formidable, with concerns about the coronavirus; higher inflation; slowing growth in China and the country’s debt crunch in its real property market and whether those problems will weigh on the global economy; and the recent energy shortages and shrinking crude oil inventories, causing gasoline lines in Europe right now; and signs that the Fed may begin pulling back on some of its monetary support later this year among the events weighing on investors’ minds recently. That said…
The equity market is still the place for investors to be these days. Until bond yields rise materially and people can earn something in fixed income, equities will remain the most attractive investment. For an extended stretch, nothing has been able to compete with equities in a financial system that has been flooded with liquidity by an ultra-supportive central bank. That’s the main reason that so far every 3% to 5% dip in equities has been treated as an opportunity to buy in.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
