Reallocating Could be Contributing to Volatility as Investors Move from Pandemic Plays to Focus on Value

The equity index futures are mixed on Monday morning as the Nasdaq Composite (GIDS) appears to be picking up where it left off on Friday. The Nasdaq led the markets lower on Friday, falling more than 1.92%. As you might expect with the Nasdaq leading the fall, the information technology sector was the worst-performing sector. The Technology Select Sector Index ($IXT) closed 1.65% lower. The Dow Jones Industrial Average ($DJI) did much better than the Nasdaq by closing 0.17% lower and its futures contracts are trading on the positive side this morning.

The VIX (Cboe Market Volatility Index) traded back to January 2021 levels on Friday, reaching as high as the 35 mark before dropping back to around 30. On Monday morning, the VIX had slipped further. Fear and uncertainty appeared to be growing among investors who are trying to digest a worse-than-expected jobs report that came out Friday morning. The economy was expected to add 550,000 jobs in November but only added 210,000. Despite the lackluster job growth, it wasn’t bad enough for the Fed to be unlikely to back off its tapering plans.

This week the Fed has more data to consider as the JOLTS Job Openings report comes out on Wednesday, initial jobless claims is scheduled for release on Thursday, and the Consumer Price Index (CPI) report comes out on Friday. The CPI report is forecasted to see inflation to have risen 6.7% in November. A number near this level or higher could prompt the Fed to taper faster.

Cryptocurrencies were hit over the weekend with Bitcoin dropping 17% from 57,000 to 47,000 levels. Fears around the financial markets including falling stocks, slow November job growth, and the Omicron variant appear to be keeping traders on edge.

Another issue that continues to linger and keep investors on edge is Chinese real estate developer Evergrande which fell another 20% overnight in the Hong Kong markets. On the bright side, the Chinese SZSE Component Index rose about 1.5% in November.

Electric vehicle makers are getting hit in early market trading. Lucid LCID was falling by nearly 13% in premarket trading on news that the Security and Exchange Commission (SEC) is investigating issues around the company’s Special Purpose Acquisition Company (SPAC) that helped Lucid go public. Other EV SPACs are also falling in premarket trading including Fisker FSR and Canoo GOEV. Rivian RIVN is also trading lower before the bell, but it was not a SPAC and went through the regular IPO process.

Last Friday, gaming stocks were also hit hard. DraftKings DKNG was down the most at nearly 9%. However, Penn National Gaming PENN, Caesars CZR, and Scientific Games SGMS were all about 4% lower on the day.

Passing Over Pandemic Plays

Gaming stocks were popular pandemic stock plays when people were stuck at home and looking for something to do. These are the types of stocks that appear to be getting hit despite the oncoming threat of the Omicron variant. Even “meme” stocks like AMC AMC and GameStop GME that epitomized pandemic speculations play fell on Friday as low as 14% and 11% respectively. Additionally, Peloton PTON, Zoom ZM, and Adobe ADBE were very popular when more people were working from home, but they are now selling off as investors take profits and start focusing on value stocks.  

At the height of the pandemic, social media played a big part in people’s lives, but perhaps now people may be using the platforms less. Social media stocks are getting hit with Meta FB falling 1.14%, Snap SNAP trading down 2.34%, Pinterest PINS dropping 4.69%, and Twitter TWTR falling 1.36%. In contrast, traditional media companies were up on Friday, with ViacomCBS VIAC trading 5.11% higher, Discovery DISCA climbing more than 3.18%, and Fox FOX rising 1.91%. The difference is that these companies have lower price-to-earnings, price-to-book, and other valuation ratios.

More traditional companies that have more appealing valuations appear to be attracting more investors. Some examples are Walgreens Boots Alliance WBA rising more than 4.28%, Walmart WMT rising 1.51%, Procter & Gamble PG up about 1.78%, Tyson Foods TSN climbing 2.24%, Campbell Soup CPB rallying 1.51%, and General Mills GIS closing 2.18% higher.

Flight to Quality

On top of valuations, when volatility increases and stocks sell-off, it’s common to see investors start moving into old “Blue Chip” companies. These are usually big companies that have been around for a long time. They also have a history of navigating hard times. This is one reason why there was such a discrepancy between the performance of the Dow Jones Industrial Average and the Nasdaq on Friday. The Dow is made up of 30 mega-cap stocks, and most of them have been around a long time. The Nasdaq is heavily weighted to technology stocks that are more growth-oriented.

Additionally, many investors moved into what is called defensive stocks. Not to be confused with defense stocks that make military equipment, defensive stocks are those that tend to perform better during sluggish or bearish markets. They include sectors like utilities, consumer staples, and health care. These are goods and services that consumers need no matter what the economy is doing. In fact, the Consumer Staples Select Sector Index ($IXR), Utilities Select Sector Index ($IXU), and the Health Care Select Sector Index ($IXV) were the top-performing sectors on Friday. 

CHART OF THE DAY: DROPPING THE BASE. The Consumer Staples Select Sector Index ($IXR—left), the Utilities Select Sector Index ($IXU—center), and the Health Care Select Sector Index ($IXV—right) have been underperforming the S&P 500 index but have been showing strength under examination of their respective relative strength indicators. Data Sources: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.  

Reallocation Pains: Market leadership changing can cause a lot of volatility as the top-performing stocks start seeing investors scale back or leave and move into other sectors and groups. Stocks like Meta FB, Amazon AMZN, Apple AAPL, Alphabet GOOGL, Netflix NFLX, and Tesla TSLA have been market leaders for a long time but are experiencing some selling. That doesn’t mean that these are bad companies or that they are no longer good stocks. It just means that some investors see them as overvalued.

The fourth quarter has been a bit hectic—it started strong in the energy, materials, and financial sectors. Then consumer discretionary and technology came alive. Recently, oil prices have dropped and taken yields with them and really muddied the picture. As investors change their portfolios in preparation for the new year, new leadership among the sectors will rise.

Yield Yo-Yo: Falling yields should be positive for tech stocks, but tech stocks are leading the selloff. Additionally, the CPI is expected to come in around 6.7% for November. Yet, the 10-year Treasury Yield (TNX) is trading off its high near 1.7%, down to 1.4%. It’s a bit of a conundrum that yields would be falling in these conditions, which may suggest that Friday’s fall in yields could have been caused by short covering in 10-year bonds. If this is the case, the 10-year yield could rally this week; this could pull financial stocks higher as well.

Lumber Grows: Lumber futures have quietly risen over the $900 level, which is about where it was a year ago. You’ll remember that lumber prices rose dramatically through the height of the pandemic—nearly reaching $1700 in May and then falling precipitously below $500. The rising lumber costs could help to drive inflation higher and cut into the homebuilder’s margins.

However, lumber markets are small potatoes when it comes to influencing inflation. Oil prices dropped about 22% in November. This could provide some inflationary relief. Oil is trading about 3% higher in premarket action on Monday morning. 

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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