Market Update

Market Update

J2 Capital Management

Trends we are seeing play out - It concerns us

  • Value stocks and cyclical's are starting to play catch-up to technology stocks, but investors are conditioned to think this is just a short term phenomenon. This has helped create a mass herding into the FANMG stocks (Facebook, Amazon, Netfilx/Nvidia, Microsoft, Google). With the boat over-loaded in those hiding out in these FANMG stocks and the Nasdaq-100 ETF (QQQ), it starts to create a poor future risk/return profile and increases the likelihood we see a sharp break lower at some point.
  • In addition to FANMG, we have seen a trend where investors are chasing the hottest momentum stocks higher. Typically these names are in the software sector. There are multiple publications and stock subscription services recommending many of the same stocks. Many investors may not even be quite sure what some of these complicated software companies do but invest in them regardless. -This is very reminiscent of 1999.
  • Many have thrown out fundamental analysis and are strictly using technical analysis and chart reading for investment decisions. When I started doing this in the early 2000's it was considered a form of voodoo science. This is adding to the market risk as everyone seems to be overcrowding the same sections of the market using the same tool for decisions.

Conclusion: Risk across the market, specifically in the momentum names is increasing and is not sustainable, at least in the short term.

Liquidity Vs. Economy

The war is on. What will drive equities over the next 6-12 months? Will it continue to be Fed liquidity and TINA ("There is no Alternative"), or will a stalled economy hurt stocks at some point? Here are two charts to ponder.

  • Balance sheets of central banks worldwide continue to expand and support markets.
  • The additional liquidity seems to be making investors comfortable putting money to work knowing central banks have their back despite economic conditions still uncertain.

  • Economic activity seems to be stalling out worldwide and we are still below Pre-COVID levels.
  • The question remains if the extra liquidity provided by central banks will be good enough to compensate for the lack of economic activity.

Hot Start for Housing

  • The median price for housing has continued to climb despite all the economic uncertainty.
  • While prices continue to rise the mortgage rates have fallen to all-time lows.
  • Essentially consumers are paying up for housing but at the same time, it has never been cheaper to borrow money for a mortgage.
  • This low rate environment coupled with growing demand due to the work from home environment has created a bullish scenario for housing as many refinance their mortgages and look for alternative housing.

Outflows

  • While we are only a couple percent away from all-time highs investors remain skeptical of the rally as outflows out of mutual funds and ETF's continue to increase.
  • This may be a bit of profit-taking as we've recovered most of the losses from March but it seems investors still aren't sold on this current rally despite the higher prices.

Optimism

(Source: FactSet)

  • The main takeaways from earnings reports so far in Q2 was a lot more optimism was expressed.
  • Some companies were able to provide guidance and it seems most are optimistic about economic conditions going forward.

Revisions

(Source: Bank of America)

  • The bar was set pretty low for most companies negatively affected by the COVID shutdowns.
  • Analysts have started to revise their earnings estimates to better reflect the economic condition and a lot of the low bars for things like industrial, financials, and consumer discretionary have been raised as a result.

FANG

(Source: JPM)

  • The FANG names continue to lead the way for the market but have been taking a breather lately.
  • We still would like to see more contributions from other names that are tied to the economy.

Value Rotation?

(Source: The Market Ear)

  • Growth stocks have continued to outperform value since the sudden pop in May.
  • With growth stock valuations becoming very stretched it would make sense to see a rotation into more value stocks as people try to gain exposure to stocks that will benefit from an economic reopening.
By J2 Capital Management
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