Stocks have been for sale in September. In fact the consecutive weekly declines just hit 3. After such a massive rally in 2021, the Market was way overdue for a breather. What’s interesting is there seems to be a lot of stress built up. Anxiety has returned. Investor sentiment has soured quite a bit. The number of Bulls fell to just 22% this week, as measured by the American Association of Individual Investors. They’ve been tracking it since 1987. This is the fewest number of Bulls all year. It was 39% just a week ago. Bulls swiftly turned Bearish. The Bears grabbed that 39% mark, which is the high on the year. The last time sentiment was this Bearish was back in January. That’s when this double-digit rally began, resulting in over 50 fresh, record highs.
Investor sentiment is considered a contrarian indicator. The herd is seldom right. Generally investors are most Bullish at tops and most Bearish at bottoms. It’s a Greed and Fear thing. The point is, the S&P is less than 3% off those all-time highs. It’s really interesting to see how Bearish people have become, still at these elevated levels. Let’s dive into that a little bit.
The path of least resistance for stocks turned lower in September on concerns about slowing growth and the spread of Delta variant. There’s an obvious linkage there. Peak earnings, rising inflation and supply chain pressures weigh heavy too. There’s more. We can’t forget about the inevitable Fed tapering. The Fed has been extremely influential in the performance of stocks, all assets really, since the Covid crash. We will learn a lot more when the Fed meets next week.
Washington always adds its standard wildcards. The widely popular bipartisan infrastructure bill is getting more complicated as Republicans and Democrats spar. That said, there’s plenty of sparring going on within the Democratic party, as Progressives and Moderates don’t agree. There is a big, but seemingly shrinking risk of higher taxes in a reconciliation bill. On top of all this is the growing threat of a government default if the debt ceiling isn’t raised.
A recent Deutsche Bank survey showed that the majority of investors (58%) are looking for a correction in the Stock Market, up to 10%, before year-end. The crowd calling for a correction is climbing. The thing is, the Market rarely does what the herd positions for. We just experienced another 2.5% sell-off this month. That is something that has been common all year. But the 10% correction that investors have been positioning for has been absent. There hasn’t even been a 5% decline this year, a rarity in and of itself. There has certainly been some significant corrective price action in sectors below the surface while the index remains elevated.
There are also some technical issues that have played a role in the September selling. Options expired Friday. It was a Quad Witch. This occurs 4 times per year with a simultaneous expiration of stock index futures, stock index options, stock options and single stock futures. This Quad Witch was the largest expiration on record, being the Stock Market has never had one at these heights. Options expiration always brings additional volume, which leads to increased volatility. Many strategies need to get unwound or rolled out to later months. There’s been plenty of volatile price action below the surface.
We consider this a downside test for the Stock Market. It’s handling it pretty well. Despite all of the negative factors outlined above, the Market continues to take things in stride. Money keeps flowing into stocks. Bank of America tracks fund flows every month. Global equity funds brought in $51.2 Billion this week, the most since March. At the same time, money market funds saw outflows of $61.8 Billion, the most since July 2020. Cash went into stocks. Large Caps benefitted most. There was the largest inflow to Large Cap stocks ever. That’s saying something. Ever is a long time.
Americans are still spending. Economic activity keeps chugging along. Retail sales had a surprise increase in August, when the Street expected a decline. Concerns about the Delta spread were reflected. Sales at Bars and Restaurants slowed while spending online rose. Back to School provided a boost. There are also signs the Delta variant is plateauing in certain regions, although the shift to colder weather presents problems in the North.
There’s also been a significant drop in inflation. The August report showed prices on imports and used cars fell for the first time this year. Commodity prices have fallen too. Iron ore fell 20% this week alone. It was driven by activity in China, both sluggish demand and Beijing trying to clean up its polluting industries. Iron ore prices are at levels not seen since the Covid lows. That is certainly good for steel producers and the cost for construction. The price of corn and soybeans has fallen too. Hurricane activity missed the corn belt, so the crop seems to be coming regular way. Unfortunately, not all commodity prices have fallen. Coffee has spiked of late. Vietnam, the No.2 coffee producer in the world, saw exports fall 8.7% from July, as the nation battles the virus outbreak. Coffee prices have jumped by nearly 47% this year, due to waves of frost and drought hurting the top producer Brazil.
Back to the Market: The S&P continues to test and hold the 50 Day-Moving-Average, something that has taken place throughout this 18-month record rally. It happened again this week. Buyers stepped in. We will soon see what Monday brings. The S&P went into the weekend right on the 50 Day, at 4432. Stating the obvious, this trend is going to work until it doesn’t.
Fortunately, the Market keeps looking past the quarrels in Washington and the political divide across the country. The Market is focused on facts and expectations of future facts. It usually doesn’t get caught up in human emotions, outside of extremes. When everyone expects something to happen, it usually prices that in ahead of time, and then does something else. Betting against the Stock Market since the Covid crash has been understandable. But it sure hasn’t paid.
We’ve been staying disciplined and taking profits throughout the year. Raging Bull Markets can be tough. They tend to overshoot on the way up. Seasonality says right now is the worst time on the calendar for stocks. September and October historically bring challenges. That’s normal. Though still early, the 2020s have been anything but normal. With unprecedented Fed support and recovering earnings and economic activity, the bias for stocks remains higher. But stocks don’t go up forever. This has been the longest stretch without even a 5% decline. Our thesis will change when the facts change.
A healthy correction will be just that. Besides, so many stocks have already corrected. There’s actually a number of investments that look really good to us now. We have some cash set aside to buy the weakness. But there’s also this: Wall Street is the only market that freaks buyers out when things go on sale. Shoppers love 10-20% markdowns at stores and online. Not so with stocks. Buyers get spooked with sell-offs. Something to remember in the coming weeks. We’re ready for whatever comes our way.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
