Last week's decidedly bearish move in risk asset prices confirmed once again the change in sentiment we've been seeing throughout the month. As we get more economic data that suggests the recovery is slowing and Congress fails to reach an agreement on another coronavirus relief package, investors are firmly moving towards defensive posturing.
A few of my thoughts on what we saw in the markets last week.
The sharp decline in the dollar that we've seen all throughout the recovery from the March bear market low looks like it's done. In its place is a sharp rebound that's reflective of a desire for safe haven assets and a general pessimism about the strength of this recovery.
A continued increase in the value of the dollar will make it tough for risk asset prices to regain their footing. Both the euro and the pound are tumbling on worries over the lack of progress on a U.K.-EU trade deal and the latest COVID outbreak in the region. That could keep European currencies facing more downward pressure through the end of the year, an improving backdrop for the dollar and a likely investor desire to retain defensive positioning.
As long as the dollar holds on to strength here, I anticipate further support for Treasuries and utilities.
Value stocks had been performing very well relative to growth throughout September, but that came to a screeching halt last week. The outperformance for value, which had reached as much as 8% over the preceding few weeks, is looking like it might be another fakeout, but maybe not.
The tech sector was due for a bounce following the September correction and I think that's exactly what we were seeing here. Tech strength carried growth higher, but it remains to be seen if it was a one-week wonder or if mega-cap tech can carry the market higher again.
If we see a continuation of the trend of investors shying away from risk and moving towards Treasuries and other safe havens, tech could turn into a laggard again, moving value ahead once more.
Cyclicals were beginning to look like a good bet as the economic recovery showed strength (materials was the top-performing sector since the March low heading into last week), but prevailing sentiment and a weakening economy has sharply reversed that trend.
Factory activity is still expanding, although modestly, and the housing market remains strong. That could provide some support for materials and industrials, but financials and energy look to have little support at all here.
Interest rates aren't rising anytime soon, which will make it tough for banks to lend profitably. With many financials tightening their lending standards, growth and revenue opportunities will continue to be slim for some time. Weakness in the energy market is reflective of a lack of demand. As long as the work-from-home trend remains in place and the demand for travel is muted, it's tough to see this environment improving.
Energy does present an interesting deep value, high yield option though.
I think Treasuries have been telling the correct story this whole time. Despite a sharp rally in equity prices since March, Treasury prices have remained firm. I'd interpret this as fixed income and big institutional traders not being convinced that all is well in the markets and the economy. Any healthy recovery would have seen traders moving out of Treasuries and into riskier assets, but that's just not what we've seen.
With the Fed committed to keeping interest rates at or near zero for years, there could be little ability for rates to move higher outside of a sharp spike in inflation. If the economy shows further signs of weakness, I expect a renewed interest in Treasuries that could push the 10-year back towards 0.5%.
Listen to what the bond market is telling us here.
Sentiment is very negative and it may not be unlikely that we could see it carry through the November election. The threat of government unrest and the uncertainty surrounding the Supreme Court nomination, the election outcome and the economic plans for the eventual winner will all likely prevent investors from getting too hopeful here.
I expect an environment favorable for bonds over stocks here and that will last through the election and possibly through the end of the year.
Much of a "re-rally" in risk assets depends on an economic recovery and the likelihood of a coronavirus vaccine in the near future. If we get an approved vaccine, sentiment reverses and we could be in store for a quick melt-up. I think it's less than likely in 2020, though, and expectations should be tempered.