Consolidation or Rotation?


After advancing at a blistering pace for the last two and a half months, the S&P 500 took its first significant steps backward since early June. Strong gains in the early part of the week gave way to a rout, and the index finished roughly 2.5% below last week’s high. In recent weeks, many had begun to question the durability of the advance led by the mega-cap stocks. With the S&P 500 increasingly tied to the fortunes of a few companies, it comes as no surprise that the market reversal was potentially triggered by heavy selling in Apple. The headline numbers were, at times, reminiscent of the action at the depths of the crisis, but there are reasons to be optimistic looking below the surface. 

The march of the mega-caps was finally broken this week after reaching levels that we can only describe as euphoric. A rally fueled by the long-term impact of the stay-at-home trade gradually morphed into excess. Bullish sentiment following the announcement of stock splits at Apple and Tesla was at odds with the economic reality. (There is no financial gain from a split.) Apple’s market cap had, at one point, surpassed that of the entire Consumer Staples sector and was on the doorstep of the Industrials before the sell-off. While we believe Apple has a long runway for growth, there typically comes a time when the growth rate being priced in by the market is no longer viable. To that end, the correction in the mega caps is likely a healthy one. Still, there is a lot of cash sitting on the sidelines that has missed the rally. We expect some of this money will view a 10% plus correction as an opportunity to enter these powerful names. In short, there is likely a good amount of support under these stocks.

Below the mega-caps, a different story is unfolding. With COVID-19 trends continuing to improve, the reopen trade is on. We’re seeing strong relative improvement from many of the “boots on the ground” type companies. Materials and Industrials are looking particularly impressive to us. This message coincides with the better than expected employment numbers posted Friday. Economists had been expecting the unemployment rate to fall to 9.8% but were pleasantly surprised with a drop all the way to 8.4% and a corresponding improvement in underemployment. We believe the economy is moving in the right direction, and there are many sectors and stocks that have room to run on that front. 

The key question is whether this is consolidation or rotation. As noted above, there is plenty of reason to think that buyers may swoop in to pick up the mega-caps “on sale.” Should they not, it could be a tough road for the S&P 500 index. With nearly a quarter of the index concentrated in FANGAM (Facebook, Amazon, Netflix, Google, Apple, Microsoft), it needs this group to continue to do well. It is very important to note that this says little about the average stock. For those more closely tied to the strength of the broad economy, things are starting to look up. This is a divergence we’ll be on the lookout for. 

As a side note, we’re keeping a close eye on how the markets are viewing the upcoming election. Over the last few days, President Trump’s polling numbers have begun to improve, and this is being reflected in the basket of companies levered to a Republican victory. We’re about two months out, and the race is tightening up. Whether Trump goes on to win or not may not matter much for the market. Congress may be of greater consequence. A tighter race lowers the odds that the Senate will switch hands. In turn, this lowers the odds of sweeping change and improves the outlook for stocks. 


Preston May, CBE®
Research Analyst


The mention of specific securities and sectors illustrates the application of our investment approach only and is not to be considered a recommendation. The specific securities identified and described herein do not represent all of the securities purchased or sold for the portfolio, and it should not be assumed that investment in these securities were or will be profitable. There is no assurance that the securities purchased remain in the portfolio or that securities sold have not been repurchased. For a complete list of holdings please contact your portfolio advisor.

This report was prepared by Donaldson Capital Management, LLC, a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Information in these materials are from sources Donaldson Capital Management, LLC deems reliable, however we do not attest to their accuracy.

An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance to certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Past performance is not a guarantee of future results. The mention of specific securities and sectors illustrates the application of our investment approach only and is not to be considered a recommendation by Donaldson Capital Management, LLC.

S&P 500: Standard & Poor’s (S&P) 500 Index. The S&P 500 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the broad U.S. economy through changes in the aggregate market value of 500 stocks representing all major industries.