Stocks Down 1% this Week; 62% Retrace Could be Key Level

For the past three weeks, equities faltered as a renewed set of concerns has undermined the generally positive narrative building a heightened sense of dread heading into critical election day (11/3). And given that stocks saw such prodigious gains since March, and especially August, is it any wonder why we are seeing some profit taking? At the same time, there are some certainties on future market performance, which I will discuss more below.

On the COVID-19 daily case data front, the seven-day delta, which is the key leading indicator I pay close attention to, breached into positive territory on Thursday indicating a slight daily increase in cases week over week yesterday. It is worth noting that this positive seven-day delta may be impacted by a data quality issue of Washington and/or Puerto Rico. Overall, it is still too early to draw a conclusion based on one -day’s data. Case trends over the next few days are worth watching.

Stocks Down 1% this Week; 62% Retrace Could be Key Level

Last Friday we hosted a webinar with Chris Murray, Head Scientist for the Institute for Health Metrics and Evaluation (“IHME”). IHME sees a US second wave of COVID-19 cases starting in early October and pushing daily deaths to 4,000 (mid-case) and as high as 8,000 per day. Nevertheless, one of the over-arching messages was that public policy can have a big influence on the outcome of this second wave. In particular, IHME estimates that masks can reduce risks by about 40%.

One of the takeaways I see from these forecasts, and every forecast for that matter, is that the process behind the model can be more important than the output itself. After all, we have seen multiple instances of markets over-reacting to models/forecasts that proved incorrect. And perhaps most importantly, even if forecasters get the data correct, how financial markets react to the data will still be uncertain. Take Israel for example. Since early June when Israel cases began to explode, the Israel equity market (ISSMYETR) has been outperforming MSCI All-Country World Index (see chart above)

STRATEGY: Is election day the key date to clear market uncertainties?

Given that stocks saw such prodigious gains since March, and especially August, is it any wonder why we are seeing some profit taking? There are some certainties, which we believe have a major influence on future market performance:

  • Bonds valuations imply higher price to earnings ratios for equities. Investment Grade bonds trade at ~53X price to coupon vs ~20x price to earnings multiple for equities
  • The Fed is dovish and supportive of asset prices
  • The US economy is expanding and recovering
  • There is $4.5 trillion of cash on sidelines
  • Retail investor sentiment measured by the American Association of Individual Investors (“AAII”) remains persistently negative

The above factors are not associated with major market tops, but rather, seem to argue stocks are in the earlier stages of recovery. And while the incoming economic data has not been universally strong, consumers seem to be healthier than is apparent. The latest Chase credit card spending tracker is showing best month, year over year, since the start of the pandemic.

As a last note, US companies survived a stress test that is five standard deviations beyond what anybody ever expected.  And most have emerged stronger and with better operating leverage.  This is the reason we see long-term equity risk premia falling, which translates into higher P/E.  And if a vaccine/cure emerges, there is a binary lift to many stocks.  

This week we also updated our trifecta epicenter stock lists which is comprised of stocks that are positively levered to the economy re-opening. The list is based on favorable views from our Global Portfolio Strategist Brian Rauscher, Head of Technical Analysis Robert Sluymer, and our Quant DQM model managed by Ken Xuan. I’d highly encourage you to refer to the updated list from our research note sent out this Friday.

Bottom Line: We should be mindful there is a level where “the worst is yet to come is priced in”. One potential level is S&P 500 3,224, because that is a 62% retracement of the gains since June. The market briefly dipped below this level on Thursday morning before finishing the week at 3,298 or about 2% above the 62% retracement level.

Figure Comparative matrix of risk/reward drivers in 2020
Per FSInsight

Stocks Down 1% this Week; 62% Retrace Could be Key Level

Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019

Stocks Down 1% this Week; 62% Retrace Could be Key Level

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