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“So the last shall be first, and the first last: for many be called, but few chosen.” – Matthew 20:16
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The market is finally getting some positive follow-through for a change. After yesterday’s 2.5% rally, the S&P 500 is poised to gap up over 1.5% while the Nasdaq is looking at an even larger gain of 2.0%, and this comes despite no let-up in geo-political concerns as North Korea fired a ballistic missile near Japan. Traders have instead chosen to focus on central bank policy and a lower-than-expected rate increase from the Reserve Bank of Australia (25 bps vs 50 bps expected). The hope is that Australia’s easing off the gas pedal is a sign of things to come from other central banks around the world.
In addition to the spike in equity futures, treasury yields are lower again with the 10-year yield down below 3.6% and the 2-year now just a couple of basis points above 4%. Crude oil is up another 1% and getting closer to $85 per barrel. The earnings calendar remains quiet for the next few days, and the only economic reports on the calendar are Factory Orders and JOLTS (both reports for August).
Usually, when you get a rally following a steep market decline, the dogs of the downturn lead the subsequent rally. It’s called the dash for trash. The logic behind the trend makes perfect sense. The stocks that drop the most during a market decline are the ones that investors expect to be the most negatively impacted by the market catalyst, whether it be rising rates, economic weakness, geo-political concerns like a war in Europe, or weather events like a hurricane hitting a major population center. Once investors perceive that weight to lift, these stocks start to levitate.
Take the war in Europe. Surging energy prices from the near or complete shut-off of energy supplies to Europe from Russia have taken a higher share of the disposable income of consumers in that region and forced some European industrials to halt production since it’s become too expensive to keep the lights on. If the Ukraine war were to end, though, energy prices for the region would likely come back in, and these consumers and companies that have been hurt the most would have the most to gain.
In yesterday’s rally, though, the dash for trash was not evident. The chart below shows the performance of Russell 1000 stocks yesterday broken out by deciles based on their YTD performance through last Friday’s close. While the worst-performing stocks YTD (deciles 7 through 10) slightly outperformed yesterday, so too did the best-performing stocks YTD (decile 1), and the other five deciles barely underperformed. In other words, traders were not just buying the ‘losers’.
So, what happened? We’ve been highlighting the extreme daily breadth readings in the S&P 500 for weeks now, and this ‘all or nothing tone’ of the markets -more ‘nothing’ than ‘all’ lately – is reflective of a market driven by macro forces. Instead of specific sector/company fundamentals acting as the primary driver of performance, factors like central bank actions or the latest comments from a Fed official have taken precedence Captain Macro is still steering the ship.
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