Any time markets recover from panic lows and recession, there is a powerful upward movement that is eventually followed by a period of digestion. It may come as a surprise to watchers of the broad indices to hear us say that the U.S. stock market has been in such a period of digestion for several months already. The broad indices (except the Russell 2000) have been making new highs — but concealed within them has been a rotation that has seen sector after sector of the market decline. As we pointed out two weeks ago, the equal-weighted S&P 500 (the “average stock”) has been treading water since May, so new index highs are an artifact of good performance by the megacap companies that dominate the index.
S&P 500 Equal-Weighted Index, Year to Date
This is a natural response to the passing of peak liquidity growth and peak economic growth. The data are still positive, but they are decelerating.
Now the torch is passing to earnings. Earnings growth remains the crucial factor for stock prices. As the easiest pandemic earnings lows have been lapped, we are likely also experiencing “peak earnings recovery” — which means simply returning to a world where the bar is higher and investors are expecting more as earnings season rolls around again. The digestive process for the pandemic rally will not near completion until companies can begin to deliver better earnings than they have needed to hitherto.
Should indigestion give way to weakness, we suggest that investors be ready to buy that weakness. This was not a recession that involved sharp contraction of credit markets and economic scarring; on the contrary. With central banks supportive and fiscal authorities in spending mode, we do not see a lot of tolerance for downside in asset prices, whether or not that is the authorities’ explicit objective.
Sector rotation is always difficult. For now, market leadership is moving back to the immediate pandemic megacap tech beneficiaries. As noted above, we like themes across the recovery and reflation trades, including both disruptive tech and inflation beneficiaries in the ag, industrials, and materials sector — as well as precious metals in the long term.
Thanks for listening; we welcome your calls and questions.
