Market Updates

Market Update: July 2021

Now that we are at the midway point of 2021, we would like to take an assessment of where we have been and where things may be going.

Where We Have Been

In the first half of 2021, the S&P 500 gained 14.4%. This performance ranks 13th out of 72 first halves since 1950 (recall we generally limit our data back to 1950 because of the extraordinary market conditions during and in the aftermath of the Great Depression and World War II). Such a performance is even more noteworthy coming on top of 2020’s strong second half of 21.5%. The current rally off the March 23, 2020 bottom has now outperformed the rallies off the bottoms in both 1982 and 2009, the strongest post-WWII rallies prior to this one (Figure 1).

Figure 1. The current rally strongly outpaces that of 1982 and 2009.

Source: FactSet and Balentine

Where We Are Going

So, what does this mean looking forward? Historical precedent suggests a strong first half begets a strong second half. However, like boxers who need to hold the ropes on occasion to catch their breath, stocks may settle down during the third quarter and catch their breath while preparing for another leg higher in the fourth quarter (Figure 2).

Figure 2. The current rally strongly outpaces that of 1982 and 2009.

Source: FactSet and Balentine

While, of course, there is no guarantee prospectively that this will be the case, we believe it is playing out that way. Consider the following market conditions at the moment:

  1. A bullish outlook is pervasive right now, as evidenced by current readings in excess of the 95th percentile for both put/call ratios and investor bull/bear surveys. This typically does not bode well for strong returns in the near term, as the pool of near-term buyers has dried up for a bit.
  2. Trends remain strong, as defined by the number of stocks within the S&P 500 above their respective 200-day moving averages. However, momentum (as defined by the number of stocks within the S&P 500 above their respective 50-day moving averages) continues to wane, as it has been doing subtly over the last few months (Figure 3).
  3. We are entering the weakest seasonal stretch of the year, July-October. The common refrain is to “Sell in May and go away,” however the reality is that May and June typically are not too bad. Rather, it is in July when the seasonality hits a bump, and this typically lasts three-and-a-half to four months, through mid-to-late October.

Figure 3. While the S&P meanders its way higher and longer-term trends remain strong…

Source: FactSet and Balentine

Figure 3(cont.) …momentum at an individual stock level continues to deteriorate.

Source: FactSet and Balentine

Putting all of this together, we expect the next few months to be relatively bumpy. However, this is not to be confused with some sort of major top; rather, this should be the pause that refreshes the bull market and allows it to gather strength to forge the next leg higher.

Some additional thoughts:

  1. Bond yields have drifted lower since early April. In our view, it is not a coincidence that rates have come down during the same time window in which the stock market has begun to experience some underlying weakness. So, is the bond market saying something that the capitalization-weighted stock market has yet to recognize? This is a possibility; however, history would suggest stocks more leveraged to a slowing economy and lower rates, such as Utilities and Consumer Staples sectors, would be performing better if this were the case. Conversely, the Energy and Financial sectors continue to be robust, a strong historical precursor to rates moving higher.
  2. So, if rates have not yet peaked in this cycle, why have rates come down since peaking on March 31? We believe there are two logical answers.
    1. Inflation Concerns. While inflation concerns are not unfounded, the level of concern associated with such sharp moves in Treasury rates is too extreme. When markets catch wind of this, price moves unwind.
    2. Rate Rising Cycles. The rate move in March on the back of inflation fears was truly extraordinary; for example, the U.S. 10-Year Treasury note rate moved from 1.46% to 1.75% during March, a large move for one month and an even larger move in the context of the rate rises over the prior seven months. As we have mentioned in the past, asset prices rarely move in a straight line. Markets get overbought/oversold in the near term and countertrend rallies ensue. In this respect, the bond market is no different than the stock market. As rates moved rapidly higher, bonds were being sold en masse and became oversold in the process and buyers have emerged over the last few months, driving rates lower. This is typical in cycles of rate rising, with the 1973-1981 extreme cycle demonstrating the point that even in the most excessive of cycles, asset prices do not move in a straight line except perhaps at the ultimate move in the asset to its destined peak or trough before structurally reversing (e.g., the stock peak in 2000 or the bottoms in 2009, 2020, which served as structural respective peaks and troughs).
  3. Discerning Growth or Value market dominance. Related to the move in interest rates is the strong bounce we saw in Growth stocks during June, raising the question about whether the Value outperformance during September 2020 – May 2021 was truly the beginning of a new Value cycle or whether it was a pause in a Growth cycle that is now resuming. Of course, both are possibilities, and we will let the market tell us where things go from here. With that said, the number of Growth stock participating in the bounce during the month was not very robust and parallels the divergence we have seen in the market overall. Like the overall market, the higher cap-weighted tech stocks carried the overall market on their backs. Growth could resume leadership if participation increases.
  4. A potential slide backwards. Conversely, it is common that with new trends after a powerful start (e.g., the trend in Large Cap Value over the nine months from September 2020 – May 2021) there is some giveback while the new trend pauses in advance of the next leg higher. The comparison that most comes to mind is what we saw in the middle of 2000 with Growth stocks in comparison with Value stocks. After peaking in early March of 2000 and declining by over 40% in about two and a half months, the NASDAQ found its legs and gained 40% over the next three months before resuming a sharp downtrend that would last several years and end up in a decline of almost 80%. Mark Twain famously noted that though history does not repeat itself, it often rhymes. While no historical comparison is an exact repetition, we cannot help but think about the microcosm of the recent tech boom and slide – the much-discussed Ark Innovation ETF (ARKK). The similarities are noteworthy, as shown in Figure 4.

    Figure 4. NASDAQ 1999-2000 vs. ARKK 2020-2021

    Source: FactSet and Balentine

  5. Overall, the stocks remain inexpensive compared to bonds, despite what many financial pundits in the press say. The yield curve remains sharply upward sloping, and, if the most recent trends hold, analyst earnings estimates remain too low, even with the imminent effect of Washington tax policy hovering over the market like the Sword of Damocles. Additionally, as endowments, foundations, and other big institutional investors must meet certain fixed spending goals, negative real rates will likely continue to encourage plans to embrace high equity allocations.

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