Financial markets enter August registering an array of extremes and at something of a "Now what?" moment.
The Nasdaq and gold at or just about at record highs, Treasury yields scraping all-time lows and the U.S. Dollar index sliding to a two-year trough, just as the bulk of earnings season is through, a tougher seasonal period arrives, and some excesses start to surface in investor behavior.
Some can't resist calling this an "Everything Rally" floated by a flagrantly easy Fed and cheapening of the dollar, but the action is more nuanced than that on careful review. Here are few things we learned last month that shape the set-up for the rest of the summer and beyond:
- The market got it just right piling into the dominant tech stocks and treating equities and the economy as a winner-take-most proposition. The common snipe about the roaring outperformance of the biggest digital-economy stocks most of the year held that it was a bubbly mania, pure momentum fueled by Fed largess and disconnected from fundamentals.
- The gaudy profits reported Thursday by Apple, Amazon, Facebook and, to a lesser degree, Alphabet, showed there was more than reckless speculation that drove those four stocks plus Microsoft up to a stunning 22% weighting in the S&P 500. Self-reinforcing network effects from global tech platforms got an extra boost from even more intense user engagement in a homebound economy.
- Bespoke Investment Group calculates that those five stocks have added $1.66 trillion in market value this year, against a drop of $1.61 trillion among the other 495 stocks in the S&P 500.
- As stark as this concentration of riches is, it makes some sense, especially in a world of sub-2% corporate debt yields in which their 3% or so free-cash-flow yields with durable growth dynamics.
The issue now is just how much more can be asked of this stock cohort at this stage. Apple gained 10% Friday after its results but Amazon failed to rise even 4% and sits below its July high. A faint hint that most of the stupendous business performance is largely in these stocks by now? The Nasdaq 100, too, has surrendered a couple percentage points of outperformance versus the firm but range-bound S&P 500 over the past few weeks.
This group owes investors nothing after its run, the stocks are near 20-year valuation highs and last week there were signs of capitulation buying by holdouts after the Big Four CEOs survived tough Congressional hearings and the glittering earnings hit the tape.
The underpinnings of the Big Tech strength remain - and likely will unless bond yields surge or an economic acceleration seems underway – but it's unclear if their two-week cooldown was enough to refresh this group for another sustained advance.
- The recent sideways choppy phase in the S&P 500 has been more frustrating for the bears than the bulls.
- The index has for the second half of July been compressed in a range between about 3180 and 3280, finishing Friday at 3271 after a late-day rally reversed losses in most everything but big-cap tech.
- The bid near the bottom of this range has been tenacious so far. Since July 15, there have been 13 trading days, and on seven of them the intraday low was between 3198 and 3216.
In this way, the market continues to act as if big-money investors are not overcommitted to equities, meaning there is no quick-triggered selling that would turn routine pullbacks into self-reinforcing slides.
For sure, the breadth of the market has not always been impressive, and of course the economy has backslid in recent weeks with the lapse of enhanced unemployment payments, Covid-case surges and resulting consumer caution.
But Friday was a good example of how traders must remain aware of "upside risks." Reports that Democrats and the White House would keep talking about a new fiscal deal this weekend were joined by others saying Microsoft might buy TikTok from its Chinese owner and private-equity firms are looking to acquire Kansas City Southern.
Individually not big market drivers but if we're in a phase where railroad leveraged buyouts, 11-figure tech deals and another round of fiscal juice are in play at once, it's tough to lean too heavily to the bearish side.
All of which sets the market up for some tests.
August begins what is easily been the toughest two-month stretch of the calendar for stocks, with higher volatility and weaker returns, on average. Election years have a particular tendency to get erratic in August, as this historical composite chart from Nautilus Research shows:
Of course, seasonal factors speak to broad tendencies over many years, but don't dictate an individual year's action. A separate study by LPL Financial of years when all four months from April through July were up for S&P 500, as this year has been, show above-average returns for the rest of those years (with the glaring exception of 2018, when a September market peak led to a 20% decline).
There is some froth building around the edges of the market for sure: The zero-commission retail speculators stampeding into moribund imaging company Kodak last week on news of a government loan; Special Purpose Acquisition Vehicles – new shell companies set up to buy something – are proliferating fast. Mostly this is the routine boundary-testing seen in bull markets, but it can get out of hand if the market keeps rewarding hubris too easily.
Another test could come from overstretched inter-market relationships. The persistent, steep slide in the US dollar – mostly against the euro – has been associated with firmer risk appetites and the run in gold. The dollar is getting oversold and sentiment is quite negative, possibly setting up a bounce that could ding stock prices.
It makes sense to enter August alert to all these interactions and the implicit bets embedded in share prices. But they don't yet amount to a convincing case to bet boldly against a market that has spent four months turning the doubts of bears into dollars for the bulls.