Flirting with a Breakout

The S&P 500 is on the cusp of breaking out of its summer trading range. Friday’s close at 3224 is just a smidge below the June 8th high at 3233. This is proving to be a difficult level of resistance to break, however. On Monday, the market briefly made a new intraday high before a sharp reversal in the back half of the day. It would go on to flirt with this level twice more during the week before settling just a hair lower. Curiously, the market’s leaders over recent months were this week’s laggards. The FANGAM names, in particular, detracted from strength in the average stock, a stark divergence from recent weeks. The pickup in “value stocks” was driven by better performance from industrials, financials, materials, and utilities. The key question is whether this is the beginning of a rotation from winners to losers or whether money is coming off the sidelines and into long-neglected corners of the market. 

This week we saw virus numbers in the US continue to get worse and began to see signs that the rebound in economic growth from the April shutdown could be slowing. At the same time, we got positive news on the vaccine development front and received largely better than expected earnings reports from the companies kicking off the season. There is an odd dynamic at play in the market. Growth names seem to be more levered to the continuation of virus concerns, and value names seem to be more levered to recovery. As we talked about last week, many of the leaders of the last few months have found ways to exploit the virus to accelerate sales growth. Those in the value camp have generally been hurt the worst by the lockdown. If that is the case, it makes sense that value would outperform growth as optimism for a vaccine grows. Still, we believe it would be unwise to count growth names out. Even with a vaccine, these companies have set their businesses on more favorable trajectories going forward. There is plenty of room for the whole market to participate. 

As another consideration, some states are reversing their reopening plans, and some are even locking down again. While this will certainly slow down the progress in the economic bounce, it also increases the chances of additional stimulus. A bill is working its way through Congress that could potentially add another $1.5 trillion in stimulus. It is tough to imagine that the market wouldn’t appreciate the gravity of this round of stimulus as it did back in March. Again, this is oddly a catalyst for the market to move higher. 

The real risk to markets remains the upcoming election and the potential for a Democratic sweep. With a sweep, it is likely that corporate tax rates would rise. This would obviously weigh on the profitability of companies just as they are getting back on their feet. Right now, we are starting to get the sense that the market may be pricing in a Democratic President. Stocks levered to a Democratic win have been steadily outperforming those levered to a Republican win over the last several weeks. Curiously, however, high tax companies are only underperforming low tax companies by a small margin. This means that the market may be pricing in a Democratic President, but is placing a higher probability on Republicans retaining the Senate. Still, nothing is set in stone. We are three and a half months away from the election, an eternity in politics. 

Thanks,

Preston May, CBE®
Research Analyst