Executive Edge

History says one feared market factor isn't the trigger in this selloff

Why the election year signals optimism despite recent market selloff
Why the election year signals optimism despite recent market selloff
Key Points
  • The Nasdaq entered correction territory on Tuesday with technology stocks down 10% in three days and suffering the steepest market losses.
  • Valuation in tech remains a concern, and the market has other risk factors: a recession, high unemployment and a stalemate on Capitol Hill over another round of coronavirus relief.
  • But the recent history of the Dow and S&P suggest presidential elections are bullish rather than bearish for stocks.  

Stocks closed out the month of August on a high note: what's typically among the worst months of the year for the Dow Jones Industrial Average and S&P 500 Index turned out to be the best August performance in over 30 years. The Nasdaq Composite Index did even better, gaining nearly 10%.

But what seemed all good just about a week ago, especially in tech stocks, has fallen apart fast.

The market rally hit the breaks and, so far in September, stocks are giving back a chunk of last month's gains. The Dow and S&P suffered their worst weeks since June and the Nasdaq Composite Index hit correction territory, with the tech-heavy index down 10% in three days. 

One feared market factor coming into focus right now offers a more bullish take that the September swoon won't hang over the markets the rest of the year. Since 1980, election years in the period between September and December tend to be fairly bullish for stocks.

Stocks are under pressure, especially in the tech-heavy Nasdaq, but the S&P 500 and Dow Jones Industrial Average have done well in presidential election periods dating back to 1980.

During these periods, stocks are consistent winners, with the S&P 500 notching an average gain of 4.2%, while trading positively 88% of the time, according to data from hedge fund information platform Kensho. The Dow has posted an average return of 2.8%, and traded positively 75% of the time.

There's one caveat to the election-period stock market rallies: this Kensho data excludes 2008, when the presidential election occurred during the start of the financial crisis and stocks erased nearly a third of their value.

For investors who see similarities between the current period and 2008 economy, that's a reason for caution.

There are other reasons for investors to be cautious over a market that has already defied the odds and gone virtually straight up since the late March Covid-19 bottom. 

Even as recent job gains have been made, mass unemployment and financial distress remain a major factor for the U.S. economy, which is currently mired in the pandemic recession. Capitol Hill dysfunction has made another round of Covid-19 relief uncertain and government debt is on pace to soon surpass GDP. And trade tensions between the U.S. and China continue to be high.

The latest polling by CNBC in key swing states shows that Democratic Party candidate Joe Biden maintains an edge on President Trump. Other national polls continue to show Biden ahead of Trump, but with the gap narrowing.

An election worker opens envelopes containing vote-by-mail ballots for the August 4 Washington state primary at King County Elections in Renton, Washington on August 3, 2020.
Jason Redmond | AFP | Getty Images

University of Pennsylvania's Wharton School finance professor Jeremy Siegel said investors should be more worried about the plunge in high-flying technology companies than the U.S. stock market as a whole.

"High valuations in the mega-cap stocks are stretched far beyond historical levels," Bruce Bittles, chief investment strategist at Baird, told CNBC on Tuesday.

The biggest tech stocks have assumed an outsize role in the market, with the mega-cap tech names like Apple, Alphabet, Amazon, Facebook and Microsoft dominating recent gains in the S&P 500 and coming to represent near-25% of the market cap-weighted index. Over the past several trading sessions, these market leaders have taken it on the chin, losing as much as $250 billion in market value in the case of Apple, which recently became the first stock to reach the $2 trillion mark, and between $100 billion and $200 billion in the cases of Alphabet, Microsoft and Amazon.

Last week, the Nasdaq suffered its worst performance since the March bottom and some of the strongest momentum plays sold off, including Tesla, which was down as much as 15% Tuesday after speculation it would be added to the S&P 500 turned out to be misplaced. One recent headline that has attracted attention as tech has fallen was a Financial Times report on Friday, citing unnamed sources, that the company was the mystery "Nasdaq whale" buying billions of dollars in call options on tech stocks and driving up valuations in the sector.

Cyclical stocks in more economically sensitive sectors, such as the S&P 500 materials and financials sectors, were the biggest winners last week.

Still, it is not just the new economy that has been flashing warning signs about economic weakness. Oil tumbled to its lowest level since June this week on fears about demand.

"The technical indicators – high margin debt, fully invested mutual funds, CBOE options data showing record call volume, Wall Street letter writers at bullish levels -- pointed to excessive optimism in the market which often suggests a consolidation/correction phase is likely," Bittles said.

The market has also just risen incredibly high, incredibly fast. Even with the recent days of selling, the S&P 500 remains above its 50-day, 100-day and 200-day moving averages.

The Nasdaq closed below its 50-day moving average for the first time since April 21..From its March 23 low, the NASDAQ is up 63.58%; for the year-to-date period, still up about 21%.Tech stocks including Apple and Tesla rose in pre-market trading on Wednesday.

The mega-cap tech stocks are still sitting on huge gains after the last three days wiped out what amounts to three weeks of the 2020 rally. At the start of the year, Apple, Amazon, Alphabet, Microsoft, Facebook and Tesla were were worth roughly $5 trillion, according to CNBC data. Their value peaked at $8.2 trillion last Wednesday, but after Tuesday's drop, the combined market value sits at $7.1 trillion.

"We believe it will take more than just a mild decline to work off those conditions," Matt Maley, chief market strategist at Miller Tabak, said in a note on Sunday. "Therefore we still believe a correction of more than 10% is probable."

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