Mid-week market update: The US markets have surged recently relative to global equity markets, as measured by MSCI All-Country World Index (ACWI). Developed markets (EAFE) and emerging markets (EM) have weakened on a relative basis.
How long can this last? The S&P 500 is testing an important resistance level that could lead to an all-time relative high for US stocks. The renewal of US leadership has coincided with a display of strength of growth over value.
A style bet by another name
This is a style bet by another name. The relative performance of the Russell 1000 Value to Growth ratio has closely tracked the EAFE Value to Growth ratio. From a technical perspective, the move appears exhaustive as the Russell Value to Growth ratio is exhibiting a positive RSI divergence. While relative breadth appears to be weak for value stocks, they are showing signs of bottoming.
Waiting for the cyclicals
One reader (Ken) has suggested that Q2 earnings season may be the catalyst for a value turnaround. There may be reason for optimism for value bulls. Value stocks have a heavy cyclical component, and forward EPS estimates have been rising steadily as we approach earnings season.
FactSet reported a record high in quarterly EPS revisions since it starting keeping records.
First up in the earnings reports are the major banks, which have value characteristics. This will be the first acid test for the market. The bulls will argue that the Fed has allowed the banks to release reserves in order to increase their dividends. The bears will argue that a flattening yield curve is negative for the relative performance of this sector, as banks tend to borrow short and lend long. A flattening yield curve is therefore negative for profitability.
A growth scare
I interpret the flattening yield curve as a sign of a global growth scare. The market is becoming concerned over the rising prevalence of the Delta variant which has the potential of halting the global recovery.
The worries are overblown. Vaccinations have been highly protective against the Delta variant. In the UK, case counts are rising owing to the Delta variant, but hospitalizations are not.
In Israel, which also has a high rate of vaccinations, investors may have been alarmed by the Reuters
headline “Israel sees drop in Pfizer vaccine protection against infections”.
Israel reported on Monday a decrease in the effectiveness of the Pfizer/BioNTech COVID-19 vaccine in preventing infections and symptomatic illness but said it remained highly effective in preventing serious illness.
The decline coincided with the spread of the Delta variant and the end of social distancing restrictions in Israel.
The most important detail was buried in the report [emphasis added]
Vaccine effectiveness in preventing both infection and symptomatic disease fell to 64% since June 6, the Health Ministry said. At the same time the vaccine was 93% effective in preventing hospitalizations and serious illness from the coronavirus.
The ministry in its statement did not say what the previous level was or provide any further details. However ministry officials published a report in May that two doses of Pfizer’s vaccine provided more than 95% protection against infection, hospitalization and severe illness.
The growth scare should pass. In the meantime, investors have been piling into growth stocks as the perception that economic growth is becoming scarce. It is an open question as to when the US and growth leadership starts to falter.
As for the S&P 500, I remain intermediate-term bullish. Ryan Detrick
pointed out that the S&P 500 closed at an all-time high last Friday after a seven consecutive day winning streak. Since 1950, this has happened only eight times and the market has trended higher after three months in every instance.
came to a similar conclusion. He found that “Initial drawdowns were minimal [and]
in most cases, stocks extended significantly higher for months (even years)”.
Sure, there have been numerous short-term warnings of negative breadth divergences, but current conditions don’t argue for a massive downdraft in stock prices. Ondra
(@overtrader_83) analyzed how the S&P 500 behaved after periods of deteriorating breadth and lagging Russell 2000. The results have been a mixed bag. While the market has resolved itself with corrective episodes, it has also roared higher more often than not.
also observed that less than 2.2% of stocks are down over 20%. Thrasher does not discount the possibility of a “sentiment-driven correction”, but major market declines have not occurred when this metric has fallen to such low extremes.
Indeed, sentiment has become a little extreme. The latest release of the TD-Ameritrade Investor Movement Index
, which measures the trading sentiment of that firm’s customers, has risen to an all-time high.
also pointed out that the DSI for both the S&P 500 and NASDAQ are at highly bullish, which is contrarian bearish.
The Daily Sentiment Index (DSI) for Nasdaq and the S&P have both moved to 91. The last time both were over 90 at the same time was late August 2020 as we headed into that peak. As a reminder readings over 90 and under 10 are ones I consider extreme.
In summary, the market is freaking out over a growth slowdown induced by the Delta variant, but those fears are overblown. Investors have reacted by buying growth and US stocks and abandoning the value/cyclical trade but it is unclear how long this trend will persist. In the short term, the market may experience some volatility as sentiment has become a little giddy, but the intermediate-term trend is still bullish.