This guest commentary was written on 7/9/20 by Mike O'Rourke of JonesTrading.
A trend that has been developing throughout the equity market recovery from the March lows is peaking this week. That trend is the continued narrowing of the equity market leadership to a handful of momentum mega cap names.
As the market has grappled with the rapid spread of COVID-19 over the past couple of weeks, the market has rotated into a handful of select “winners” who are expected behemoths and considered beneficiaries from the pandemic. Since the start of the month, the Covid Casualties have been punished, with Financials and Industrials both down more than 2%, while Energy has lost nearly 9% despite oil’s resilience.
Over the past week, the groups have been joined by Health Care, Real Estate, Utilities and Materials. Month to date, Consumer Discretionary is up 6%, Communications is up nearly 5%, and Technology is 3.3% higher. Those are the sectors where most of those mega cap leaders reside.
This behavior culminated today with decliners in the Russell 3000 outpacing advancers at a rate of 4.6 to 1 on a day when the Nasdaq 100 gained 82 basis points. The Nasdaq 100 outperformed the S&P 500 by 138 basis points today.
The last time there was such a divergence between the S&P 500 and the Nasdaq 100 with that type of Nasdaq outperformance was exactly a month ago, the two days immediately before the S&P 500 declined 5.9% and the Nasdaq 100 declined 5% the day after Chairman Powell’s FOMC press conference.
Everyone will recall Powell was concerned about the economy’s ability to fully recover and noted we would still have millions of people unemployed when the economy does recover. In the past couple of days, several companies have announced or indicated that significant layoffs are coming - United Airlines, Well Fargo, Walgreen’s and Harley Davidson.
Tech startups have laid off nearly 70,000 people. Bed, Bath & Beyond is cutting its stores by 20%, and numerous colleges are slashing programs. These are simply the announcements from this week.
Investors see the writing on the wall. With each passing day that the virus spreads, not only does hope fade that trends can reverse, but the weakness will likely accelerate. Some in the market are rotating into the mega cap “winners” who are expected to continue to outperform as the economy stumbles.
These winners are larger weights in the Nasdaq 100 than the S&P 500. The move has been so extreme that the Nasdaq 100 has hit new all time highs. As of today’s close, the Nasdaq 100 has compounded its gains at 22% per year over the past decade, that compares to 13% for the S&P 500.
The narrowness of the rally is highlighted by the fact it is largely the same names driving the gains in both indices, simply at different weights.
The Nasdaq 100’s outperformance of the S&P 500 has blown off to the upside, to the point where it is well in excess of the 2000 bubble peak.
Although market peaks have become nearly extinct, it is common for the rotation to narrow into the leaders believed best positioned to outperform in the recessionary environment. What is often overlooked at this stage is that outperformance frequently does not translate to absolute gains.
As employees are laid off, budgets are cut and savings exhausted, the spending slows everywhere in the economy. Nobody is truly insulated, and very few businesses truly benefit. Presidential challenger Joe Biden leads in the polls, and today he advocated a focus on the real economy over the financial economy.
Whether he is elected or his plan comes to fruition remains to be seen. That said, he specifically stated he would target these mega caps who game the tax system and will raise the corporate tax rate to 28% from 21%. As we have noted in the past, the most the S&P 500 ever earned prior to the 2017 tax cut was ~$125.
The levers that drove the final leg of the bull market are flipping the other way. Of course, there will be those who argue the Fed will be there to bail the tape out. We agree with that thinking, but it is better to make those wagers at lower prices when the market is under duress (as it was in March).
EDITOR'S NOTE
This is a Hedgeye Guest Contributor piece written by Mike O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.