Market Commentary | June 14, 2021

Turn Turn Turn: Rotations Persist

Turn Turn Turn: Rotations Persist

Key Points

  • Sector performance trends have been literally all over the map (quilt).

  • Speculation remains rampant, but also shifty in terms of “shiny new objects” in the sights of retail traders.

  • Bond yields may continue to hold a key to performance biases.

Trends within the stock market have become less binary and less obvious. For the first six months or so off the March 2020 market low, the obvious leadership bias was pandemic winners—specifically the “big 5” largest stocks in the S&P 500. Starting in early-November, when vaccine development news initially hit the wires, the market was decidedly less narrow, with leadership shifting toward cyclical- and value-oriented sectors. 

At the start of this year, speculation really heated up—notably among the “newly-minted day traders”—especially in market segments somewhat out of the mainstream. These included heavily shorted stocks, IPOs, SPACs, non-profitable tech stocks, crypto-currencies; and of course, meme stocks. When the stock market began to price in not just an economic recovery, but a surge in growth and a move from recovery to expansion, the market had a low-quality flavor to it. This is in keeping with the tendency of the market historically to reward weak earnings/weak balance sheet lower-quality for brief periods when the market is pricing in a growth surge—those stocks typically have more “leverage” to the surge in growth.

As the most speculative leadership areas came off the boil in February, the market shifted back toward traditional fundamentals and leadership shifted toward value characteristics (aka factors). More recently, the market’s shift back toward growthier segments of the market alongside the move down in the 10-year Treasury yield, may be signaling that we are in the midst of the peak in both the growth rate for the economy and corporate earnings.

Shifty sectors

Let’s first look at sector rotations over the past year. As you can see below, we modified our traditional asset class “quilt” chart, which typically shows broad asset class performance on a year-to-year basis. In this case, we are looking at S&P 500 sector performance on a month-to-month basis. Each of the S&P’s 11 sectors are represented by a color, and if you squint your eyes a bit you will see that there is no particular color pattern evident. In fact, leadership has often been quite volatile, with sectors like Energy spending as many months at the top of the leaderboard as it has at the bottom. Even the typically-staid Utilities sector has been at the top of the leaderboard twice, while at the bottom five times. As you can see in the separated far right column, Financials have been the best-performing sector over the past year, yet it only topped the leaderboard in one month.

061421_sector quilt

Source: Charles Schwab, Bloomberg, as of 5/31/2021. Sector performance is represented by price returns of the following 11 GICS sector indices: Consumer Discretionary Sector, Consumer Staples Sector, Energy Sector, Financials Sector, Health Care Sector, Industrials Sector, Information Technology Sector, Materials Sector, Real Estate Sector, Communication Services Sector, and Utilities Sector. Returns of the broad market are represented by the S&P500. Returns assume reinvestment of dividends and interest. Indices are unmanaged, do not incur fees or expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

Shifty speculations

Next we can see the volatile patterns among the aforementioned areas where speculation has been most rampant. After significant rallies at the start of the year, the maximum drawdowns for some of these “hot pockets” have ranged from -15% (for retail favorites) to -47% for Bitcoin. There is no area of prior speculative froth that has been immune to the rotational nature of the corrective phases.

Market’s “Hot Pockets” Take Some Hits

061421_basket stocks price chart
061421_basket stocks table

Source: Charles Schwab, Bloomberg, as of 6/11/2021. Data indexed to 100 (base value = 12/31/2020). Goldman Sachs (GS) most-shorted basket contains the 50 highest short interest names in the Russell 3000; names have a market cap greater than $1 billion. GS retail favorites basket consists of U.S. listed equities that are popularly traded on retail brokerage platforms.  GS non-profitable tech basket consists of non-profitable U.S.-listed companies in innovative industries. Technology is defined quite broadly to include new economy companies across GICS industry groupings. ISPAC Index is a passive rules-based index that tracks the performance of the newly listed Special Purpose Acquisitions Corporations (“SPACs”) ex- warrant and initial public offerings derived from SPACs since August 1, 2017. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance does not guarantee future results. 

Shifty factors

As noted above, the factor of value (distinct from the Value indexes), has been the best performer so far this year, with the growth factor bringing up the rear. You can see this in our heatmap of Bloomberg factors below. Looking back over the past year, volatility has been the best factor, with profitability trailing to a significant degree. The recent shift in leadership direction has tended to favor trade activity and volatility again; with the meme stocks in particular back in the spotlight.

061421_factor table

Source: Charles Schwab, Bloomberg, as of 6/11/2021.  For illustrative purposes only. Past performance is no guarantee of future results.

Shifty memes

There is probably no greater attention-grabber within “investing” (gambling) circles than the meme stocks. As detailed in an excellent report from our friends at BCA Research, fueled by zero-commission trading (Schwab may have had something to do with that) and an anti-establishment mindset, social media has given millions of retail traders the ability to coordinate attacks on individual companies. So far, the volatility in meme stocks has had a very limited impact on the traditional stock market averages. That said, as BCA points out, growing interest in meme stocks has been positive in the sense that it’s drawn funds into the stock market, boosting prices and liquidity in the process.

As you can see in the Google Trends chart below, the term “meme stock” initially soared in January, then dissipated, before soaring to fresh new heights recently and then descending again. Round one was in January when GameStop and a small handful of other “questionable fundamentals” stocks. As highlighted by BCA, tales of instant riches spread like wildfire, motivating yet more new traders to enter the game—with the lure of easy money. The implosion of Melvin Capital—the hedge fund which had a short position in GameStop accounting for well more than the entire float of shares outstanding—sent a message to the Reddit-fueled “flash mobs” of traders that they could beat hedge funds at their own game.

Meme Stocks Enter Lexicon

061421_google search trends

Source: Charles Schwab, Google Trends, as of 6/8/2021. Numbers represent search interest relative to the highest point on the chart for the given region and time. A value of 100 is the peak popularity for the term. A value of 50 means that the term is half as popular. A score of 0 means there was not enough data for this term.

Some have described the resultant shifts in what represent the “shiny new objects” among the meme stocks as a game of hot potato, or musical chairs, or cat-and-mouse, or pin the tail on the donkey. (Is there something to be said about those all being games children play?) We don’t cover any of these stocks (or any individual stocks for that matter), but do suggest that investors take great care if they’re tempted to succumb to the themes of FOMO (fear of missing out) and HODL (hold on for dear life) with regard to the meme stocks and other speculative hot pockets of the market.

Using three of the most popular meme stocks since the frenzy began—GameStop, AMC Entertainment, and Clover Health—the first chart below shows how the frenzy has been fickle, with GameStop being January’s poster child; followed by AMC in May and Clover Health more recently. From its low in the beginning of January, GameStop soared more than +1,900%, while AMC surged nearly +900%. The initial late-January to mid-February drawdown for GameStop and AMC were -88% and -72%, respectively. 

The latest drawdowns from their early-June highs were -37% and -49%, respectively. Clover Health has been a more recent phenomenon; with a +225% gain from mid-May until early-June; followed by a drawdown of -46% in a single day last week (June 7). In any “normal” universe, Clover’s swings would be wild; but as you can see in the chart (which indexes each stock to 100 at the start of the year), it’s barely noticeable. Finally, BCA’s research found that nearly 80% of the returns on meme stocks were earned overnight (i.e., between the close of trading and the following day’s open).

Meme Stocks Take Traders for Ride(s)

061421_gme amc price chart

All referenced companies were chosen for illustrative purposes only and should not be considered recommendations, offers to sell, or solicitations of offers to purchase. Past Performance is no guarantee of future results.

Shifty inflation concerns

Moving to more fundamental market drivers, as noted above, the move lower in the 10-year Treasury yield—from its peak of 1.74 at the end of March to 1.45% as of Friday—has been an important stock market driver. The benign yield environment may be sending a message that the current spike in inflation we’re witnessing will be “transitory,” as the Federal Reserve expects. 

When yields were spiking in March, the growthiest of all sectors—Technology—was taking it on the chin (as you can see in the quilt chart above). In fact, as you can see below, the correlation between the Technology sector and the 10-year Treasury yield has plunged into the deepest negative territory since the mid-1990s. The difference between then and now is direction: yields were falling and tech stocks were rising throughout the 1990s. The opposite was the case when yields were moving up in March of this year.

Tech Stocks Inversely Correlated with Treasury Yields

061421_info tech v 10y 60d correl

Source: Charles Schwab, Bloomberg, as of 6/11/2021. Correlation is a statistical measure of how two investments have historically moved in relation to each other, and ranges from -1 to +1. A correlation of 1 indicates a perfect positive correlation, while a correlation of -1 indicates a perfect negative correlation. A correlation of zero means the assets are not correlated.

Since yields rolled over, most growthier (and expensive) areas of the market have tended to fare better. As you can see in the breadth charts below, following the yield spike, breadth for both the NASDAQ and Russell 2000 began deteriorating rapidly; while it remained healthy for the S&P 500. On May 12, less than a third of stocks in the Russell 2000 and NASDAQ were above their 50-day moving averages; subsequently doubling with impressive breadth rallies. In the case of the percentage of stocks above their 50-day moving averages, both indexes have fully closed the gap with the S&P 500.

Breadth Convergence

061421_50d ma

Source: Charles Schwab, Bloomberg, as of 6/11/2021. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

061421_200d ma

Source: Charles Schwab, Bloomberg, as of 6/11/2021. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

SentimenTrader did some work on this in response to my posting of these breadth charts on my Twitter feed last week. They found that in the past, when there had been similar divergences, the S&P 500 was weak over the subsequent couple of months; with better subsequent performance by the Russell 2000 and NASDAQ. This is where it’s appropriate to add the classic qualifier: Past performance is no guarantee of future results.

In sum

I was asked a question last week at the end of a client webcast about whether there was one particular indicator on which I’m keeping a close eye. With little hesitation I said the 10-year Treasury yield. It’s often said that the bond market sends a more reliable (and rational) message about the economy (and/or inflation) than the more volatile (and fickle) stock market. The reprieve from the March spike in yields has been instrumental in the shifting leadership trends within the stock market. Another shift higher in yields could put renewed pressure down on higher-multiple (growthier) areas of the market.

The market has become less binary in terms of leadership, with macro factors having a waning influence in favor of company/industry fundamentals. To use an age-old term, it’s a stock-pickers’ market. I continue to believe stock-oriented investors should take a hybrid approach—with a focus on both growth and value factors, regardless of sector biases within Growth or Value indexes (in other words, emphasize lower-case “g” and “v” more than upper-case “G” and “V”). Investing based on fundamentals will never go out of style; which is a good segue to how I’ll close on this note: neither FOMO nor HODL are investment strategies.