Stocks rose Tuesday as investors began to pick up some beaten-up cyclical groups of stocks, leaving high-flying tech stocks alone for once. Bank earnings posed a mixed bag of results, but that didn’t do much to hold back sentiment.
The S&P 500 rose 1.34%, with the tech-heavy Nasdaq up just 0.94%. The 10-Year Treasury yield rose to 0.63%. Yields rise when prices fall.
Cyclical sectors have been in correction or bear market territory since June 8, the peak of financial market optimism on a V-shaped economic recovery from COVID-19 so far. Oil is in a bear market, while consumer discretionary is in correction territory since that date.
Since June 8, tech stocks have seen earnings estimates revised upwards as growth trends like 5G devices, e-commerce and streaming have continued to shine. Those trends can often overpower economic headwinds, attracting return-hungry investors.
But while big tech has experienced valuation expansion, cyclical value has seen valuation compression, leading to a large discrepancy.
Tuesday, the Vanguard S&P 500 Value ETF (VOOV) - Get Vanguard S&P 500 Value ETF Report rose 1.54% Its growth counterpart (VOOG) - Get Vanguard S&P 500 Growth ETF Report rose just 1.23%, as tech earnings, which may fail to justify current price levels, loom. The growth fund is down 2% in the past few days.
Powering value stocks were consumer discretionary, oil, materials and industrials. And small caps, some of which are very sensitive to economic changes rose as well, with the Russell 2,000 Index up 1.56%.
This all came even as bank earnings did not paint a positive picture of the economic recovery. JPMorgan (JPM) - Get JPMorgan Chase & Co. (JPM) Report, Citigroup (C) - Get Citigroup Inc. Report and Wells Fargo (WFC) - Get Wells Fargo & Company Report all reported earnings. While JPM and Citi beat revenue and earnings estimates on the strength of capital markets revenue, their lending businesses looked weak. Provisions for credit losses, or cash set aside as an expense to absorb potential credit losses, were largely worse than expected for all three banks. Those provisions totaled $25 billion. In all of 2019, there was virtually no cash set aside for poor credit. This is a negative signal for the credit and spending of consumers, where revenue weakness was spotted most in the bank reports.
JPMorgan shares rose 0.56%, as CEO Jamie Dimon made clear the company’s dividend is protected by an exceptionally strong balance sheet. Citigroup made limited mention of dividends and the stock fell more than 3%, even though it is trading at below book value. Wells Fargo cut its 2020 dividend to 10 cents from 51 cents and the stock fell more than 4%.
But other cyclical stocks had been beaten up too harshly for these earnings reports to cause more selling pressure.
Notably, investors are still hoarding a lot of cash, a bearish signal. The average fund manager, according to Bank of America Global Research, is holding 4.9% in cash, above the 10-Year average of 4.7%. The increase cash holdings, which took place in March and April, had stabilized, before ticking up again of late for some funds. While a signal of tepidness, this also means investors may have some additional risk tolerance, which could prevent further stock market downside from becoming catastrophic.
Here’s what Wall Street’s saying:
Jasper Lawler, Head, Research, London Capital Group:
"Massively overbought conditions in many big tech stocks saw some profit-taking before tech earnings announcements next week.”
Team, LPL Financial:
"The trajectory of the economic recovery remains uncertain, but based on the depth of the contraction and a multi-staged recovery, our 2020 base case gross domestic product (GDP) forecast calls for a 3–5% contraction in GDP. Although this recession may end up as one of the shortest on record, the eventual recovery may not be strong enough to get economic activity back to 2019 levels by the end of 2020. Ongoing unemployment in industries that are more challenged because of social distancing may likely delay consumer spending’s return to 2019 levels until 2021. We believe the optimistic economic recovery scenario reflected in stocks may limit their upside potential over the rest of the year. Our 2020 year-end S&P 500 Index target range is $3,250–$3,300, based on a price-to-earnings ratio (PE) of slightly below 20 and a normalized earnings per share number of $165. Our year-end base-case forecast for the 10-year US Treasury yield is 1–1.5%, which would be the lowest level to end a year on record, if realized."
David Lefkowitz, Head, Equities, Americas, UBS:
“The pace of the profit recovery will be highly contingent on virus trends and continued government support. Despite a recent increase in infections in parts of the country, local officials should be better prepared for these outbreaks. Our S&P 500 EPS estimates of USD 122 (–26%) and USD 156 (+28%) for 2020 and 2021 remain unchanged. The equity market is pricing in a substantial—but not full—normalization in activity. We expect additional upside over the next 12 months, especially as progress is made on medical therapies. Our June 2021 S&P 500 price target remains 3,300. Valuations for growth stocks are looking quite stretched but may remain elevated until economic growth convincingly improves."
David Konrad, Banks Analyst, D.A. Davidson & Co:
"JPM reported a capital markets fueled strong quarter with reported earnings of $1.38 [per share] versus the street of $1.04. The results fell short of our estimate of $1.55 due to reserve build of $2.19 [per share] vs. our $1.40 estimate. Although this level of capital markets revenue is unlikely sustainable, we view it more as an accretive capital raise benefiting from the Fed's strong liquidity infusion into the markets. Stock should outperform peers today. it would be fair to say that the level of capital markets is not sustainable. However, we believe the strong reserve build will give the market more comfort that JPM has better ring-fenced riskier assets supporting a better outlook in maintaining current dividends.”