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Bears Thwarted Again by Stock Market That Believes in Recovery
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One day, maybe, it will end up being true that it was a bad idea to plow money into retailers and cruise lines whose existence was under threat by the coronavirus. Right now, that case is in deep trouble, as the market rallies with each new sign of economic recovery.
It’s a moment of reckoning for bears who never stopped sounding alarms about putting faith in the Federal Reserve and chasing shares whose valuations swelled to a 20-year high. Friday’s jobs report suggests equity resilience reflects not just central bank liquidity, but asset prices that correctly anticipated a quicker turnaround than everyone else.
“The market has a pretty good record on calling the direction on things. When you combine that with some basic economic signals, the market is a lot closer to right than a lot of the prognosticators,” said Brad McMillan, chief investment officer at Commonwealth Financial Network. “There’s a lot of talk about how Wall Street and Main Street are disconnected, but at the same time Wall Street depends on Main Street.”
One group whose acumen is being affirmed is individual investors, whose historical reputation for poor market timing is being rehabilitated. Discount brokerages like Charles Schwab and TD Ameritrade saw record new accounts opened and trading volume in the first part of the year, trends that evoked dread among professionals and are now looking almost perfectly prescient.
30,925 in BrazilMost new cases today
-8% Change in MSCI World Index of global stocks since Wuhan lockdown, Jan. 23
-0.8273 Change in U.S. treasury bond yield since Wuhan lockdown, Jan. 23
-2.3% Global GDP Tracker (annualized), May
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“I had thought the market was ahead of itself in April and May and the real economy was doing much worse than the market would suggest,” said Chris Zaccarelli, chief investment officer for Independent Advisor Alliance. “Now that it’s clear the economy actually is on the mend, I’m pleasantly surprised that there wasn’t a disconnect.”
Companies hit hardest by the lockdown soared again Friday after a broad gauge of payrolls rose by 2.5 million in May, igniting stock-market bets that the worst is over for the economy. A Goldman Sachs basket of companies with shaky finances jumped 9.8% for the best week on record relative to the market. Hertz Global, a car renter that just filed for bankruptcy, has now more than tripled over two days.
The recovery trade went into overdrive following the Labor Department’s report, amplifying gains that built all week as traders shifted out of stay-at-home tech megacaps and health-care to embrace financial, energy and transport companies. The speed of the gains are impressive: an index tracking airlines was up 37 % over the week while banks jumped 17%.
“This rotation feels like it’s coming more because the economic data is showing us reason to be optimistic. This week was a big week for that case,” said Brian Nick, chief investment strategist for Nuveen. “Even if the economy can’t fire on all cylinders yet, it’s ready to go.”
Stocks rose for a third week, with the Nasdaq 100 Index and the Nasdaq Composite Index both erasing bear-market losses to climb to an intraday all-time high. The S&P 500 advanced 4.9% while the Dow Jones Industrial Average climbed almost 7%. Both scored their best week in two months.
The worse a company’s finances, the better it did this week. A basket of firms with the highest risk of default rose 12% through Thursday, nine percentage points more than firms with better credit health, data compiled by Bloomberg show. Since bottoming in March, those stocks with riskier finances have beaten their more stable peers by 30 percentage points.
Gains are being sustained by speculation that the corporations whose finances put them most at risk will thrive as the economy improves. Also aiding the stocks is an increase in investor demand for shares trading at lower valuations.
“I can see them making a shift, saying, ‘Ok, equities still represent good return potential but maybe it’s a better risk-reward to go with the lesser valued sectors and names,” Mike Zigmont, head of trading and research at Harvest Volatility Management, said by phone. “I can see them shifting from stocks where the P/E has already inflated to stocks where the P/E hasn’t inflated that much.”
That’s a playbook that exchange-traded fund investors followed, dumping tech darlings in favor of laggards such as banks and small-caps. In the past week, they flocked to funds focused on small caps and financial firms, while pulling cash out of large-cap technology. The Financial Select Sector SPDR Fund, ticker XLF, took in roughly $875 million this week. Investors poured $900 million into the iShares Core S&P Small-Cap ETF, ticker IJR, on Thursday alone, the most in two years. Meanwhile, the Invesco QQQ Trust Series 1, QQQ, lost $2.3 billion this week, the most since Oct. 2018.
The end result of such rotation: a market whose technicals look healthier, instead of a lopsided one driven by a handful of tech giants. An equal-weight version of the S&P 500 that gives Coty Inc. just as much clout as Microsoft Corp. rose 9.6% this week, doubling the returns of the regular market-cap weighted benchmark for the best relative return in two decades.
“A lot of this is really, ‘Hey, I think we’re going to get going back to work, so I’m going to buy some of these stocks that I think will benefit if spending starts pretty quickly,’” said JJ Kinahan, the chief market strategist at TD Ameritrade. “There’s been the optimism trade for the last few weeks, that we would get going faster than people expected.”
— With assistance by Sarah Ponczek, and Katherine Greifeld