Markets knocked off their August highs as reality takes hold

After hitting record highs during August, the US stock market sold off sharply in early September as the tech stocks that have driven the seemingly unstoppable rally in equities since March experienced a sharp sell-off.

The multi-trillion-dollar stimulus programs introduced by governments and central banks have fuelled stock markets to heady heights. However, it is the big 5 tech stocks, Facebook, Amazon, Apple, Netflix and Alphabet (FAANG), Google’s parent company, that have been responsible for most of the gains in the headline indices, particularly the Nasdaq. The rest of the stock market constituents have remained in negative territory year to date. Within the S&P500 Index, the FAANG stocks have gained 55% this year so far compared. The other 495 stocks together declined by 5%. According to Yardeni Research, the FAANGM, which includes Microsoft, now comprise 26.3% of the S&P500 Index.

Japan’s Softbank is also believed to have contributed to the rally in tech stocks, allegedly buying as much as $4 billion in individual stock options of some of the biggest tech companies like Amazon and Microsoft.

The tech stocks have benefited from the tailwinds of anticipated demand for things like software, semiconductors, streaming services due to the coronavirus and more people working remotely. But concern has been growing that investors are pricing in overly optimistic growth forecasts for the mega-tech stocks, with these stocks trading at a price-to-earnings ratio of well over 20 times. Yardeni Research puts Facebook’s forward price-to-earnings ratio at 29.5 times, Amazon at 80.7, Netflix at 63.3 and Google (Alphabet) at 29.5.

We believe valuations have become stretched and that Thursday’s pullback in tech in the first week of September serves as confirmation that these counters have moved ahead of the underlying fundamentals. This was particularly evident in the surge in Apple’s and Tesla’s stock prices earlier in the week, which was driven by demand from certain market constituents as both companies executed stock splits that should have no impact on their market capitalization. Apple, Tesla, Zoom, and Salesforce.com experienced the most notable losses on the day. Certainly the growth prospects of these tech giants will continue to be a polarizing topic of debate, but we continue to be extremely mindful of valuation in the context of growth opportunities as parts of the global economy experience fundamental changes.

Lower for longer interest rates weigh on banks

Banking stocks remain under pressure, although some market commentators see the sector gaining ground on the back of attractive valuations and on a relative basis. However, the banks will still have to contend with lower for longer interest rates and weak loan growth, which raise revenue concerns. The US Federal Reserve is said to be considering engaging in Yield Curve Control to increase yields at the longer end of the curve, which would provide some reprieve for the financial sector.

Global economic recovery still patchy

Economic statistics are still painting a mixed picture in the developed countries, with some sectors showing encouraging signs of life and others still sluggish. The latest US employment statistics surprised on the upside, while Canadian jobs data came in slightly below expectations. In the US, 1.4 million jobs were created in August, and the unemployment rate dropped materially to 8.4% versus 10.2% the previous month. Meanwhile, in Canada, 245,800 jobs were created versus the 275,000 anticipated, and the unemployment rate declined to 10.2%.

It was the end of an era in Japan when Abe Shinzo unexpectedly announced he was resigning due to health concerns. Japan was the first economy inducted into the negative economic growth club in the late Nineties, and more than two decades later, it is still struggling to get out of its low growth, low inflation gap.

Gold races to new highs

Gold found its place on the leader board during August as it broke through $2 000 dollars an ounce for the first time before retracing somewhat and trading around $1 950 into September. The precious metal’s surprise increase prompted concerns that inflation may be on the rise because of its long-held status as one of the best inflation hedges. However, the jury is still out on whether to worry more about inflation or deflation during the months and years ahead, given the still dismal global economic situation.

Demand for the precious metal waned in early September when US manufacturing statistics show the sector had expanded at its fastest pace since 2018 as the economy benefited from states emerging from lockdown. However, a resurgence in cases may dent this early recovery.

The dollar weakened by 10% during August as the US Federal Reserve actions, including a shift to inflation averaging, indicated that interest rates are likely to remain at historically low levels for, possibly, years to come.

Crude oil regained lost ground during August in line with a pickup in global demand and mobility as lockdown restrictions eased. However, the Brent crude oil price has struggled to hold above $45 a barrel but has expected to consolidate above $40.

While the oil sector will bear the brunt of the electric vehicle revolution that is underway, as companies like Tesla ride the wave of the growing demand for clean energy modes of transport there is likely a few puffs left in conventional energy as we shift to a “clean economy”.

COVID-19 still hanging over the economic outlook

With COVID-19 infections still on the rise in the US, Brazil and India, and some of the European Asian nations second waves, the pandemic remains a significant challenge for governments and central bank efforts to get economies going again. Globally, COVID-19 confirmed cases had exceeded 25 million and 875 000 deaths. The US has more than 6 million confirmed cases, and Brazil and India more than 4 million.

The outlook for the economy remains highly uncertain. Still, August saw the death knell of any hopes that the developed countries would experience a V-shaped recovery in the second half of the year. Most bets are now on a U-shaped recovery, as long as governments manage to get COVID-19 infections under control and reopen economies further. Until then, volatility and unpredictably are likely to predominate in financial markets. As such, investors will be called on to practice patience and avoid giving in to short-term emotionally driven decisions.

Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm with a dedicated team of investment professionals that manage investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 20 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at gpowell@allvista.ca