After four months of a blistering rally off the March lows, the market’s leaders have begun to tire. With earnings rolling in and largely beating expectations, participants are taking money off the table in the year’s winners. It is a classic buy the rumor, sell the news scenario. For months now, the market has been saying that earnings estimates are too low, especially for growth stocks. We now have evidence to that end. Still, expectations must ultimately be bounded by reality. While many companies smashed their estimates and raised guidance, there have been few absolutely mind-blowing reports. They’ve done enough to justify the rally, but not enough to move significantly higher from here. A consolidation phase is ongoing, masked only by better action from the value end of the spectrum. Time will tell if this is a rotation or a pause.
The FANGAM (Facebook, Amazon, Netflix, Google, Apple, Microsoft) names had an especially rough week. Microsoft’s earnings report on Wednesday was a catalyst for selling across the group. Though they beat sales and earnings expectations for the quarter, there was a notable deceleration in their cloud infrastructure business. This unit has been a key growth engine for the company, and the slowdown raises questions about the sustainability of such high growth rates for this group as a whole. With this adding to the great uncertainty looming over the next several months, it is not surprising that participants would look to lock in gains at these levels. Going forward, it will be key to the broader market that these companies hold their ground technically. A major breakdown for the group could mean trouble for the whole market, given its significant weight in a number of indices.
On the value side of the spectrum, we believe things are looking much brighter. With hopes for a timely vaccine building, some of the names hit hardest during the crisis have begun to perform better. Energy, Materials, Financials, and Staples all had great weeks. A softening dollar may also be boosting some of the group. Commodities historically do better with a weaker dollar as do companies with significant exposure to foreign sales. We expect a change in inflation dynamics between the U.S. and Europe is driving this narrative. For the first time in over a decade, Eurozone inflation is tracking at a higher rate than U.S. inflation. This is a negative for the dollar. We’ll have to see if these trends persist, but their emergence is timely with the recent weakness in the crisis leaders.
Preston May, CBE®
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