Chemical Reaction

Chemical reaction.  Stocks gave up ground yesterday, pulled down by tech shares in a day of mixed news.  Russia claims to have a vaccine, despite a lack of broad trials, small businesses are optimistic about hiring in the future, producer prices tick up, and Congress continues to sleep on the job.

N O T E W O R T H Y

What goes up…. Yesterday’s trade was confusing for many investors.  At a high level, gold fell quite a bit (which is rare in recent times), tech fell (which is not quite so rare anymore), cyclical stocks rose, lockdown stocks slipped, and bond yields jumped.  On the surface it would appear that investors were putting on an optimism trade after Vladimir Putin made a curious announcement that Russia had won the race for a virus vaccine. Competition aside, news of a vaccine IS positive.  Stocks initially responded positively but it didn’t take long for traders to realize that the announcement was lacking in certain, let’s call them, important details.  The most significant of which being that the vaccine was only tested on animals, 76 patients, and Putin’s very own daughter.  The announcement did however serve as an important reminder of how close we might be to getting a proven vaccine with some Phase 3 results expected as early as late next month.  It should not then be surprising that the winners column included cruise lines, airlines, banks, and materials stocks while the losers list included stay-at-home favorites such as Clorox and gaming stocks.  The S&P500 actually came within striking distance of its all-time high earlier in the session before fading and going red in the final hour of trade. Stock indexes were ultimately pulled down by tech stocks.  Tech stocks are not technically stay-at-home stocks, so why did they sell off?  There is no question that tech has been a leader in the turnaround of the stock markets, helping the indices go from their March depths to all-time highs. The reason appeared simple on the surface: tech is impervious to cyclical moves in the economy. That fact is mostly true, but more importantly, most of those tech stocks actually have logged solid performances, despite virus-related disruptions.  Before the past two days’ declines, the S&P Information Technology sector rose by +63% from its March lows.  With uncertainty all around, there were very few areas competing for investment dollars. Once other potential growth areas began to emerge, investors, as they typically do, rotate capital into areas which have more potential for growth.  Considering the sector’s recent meteoric rise, it is not unreasonable to assume that investors may be willing to lock in some profits.  BUT, that does not mean that the sector is headed for the scrap heap.  The sector still offers the greatest opportunity for earnings growth and it continues to operate well, despite the current economic rout.  With hopes that things may be improving, there are simply other sectors competing for investment dollars.  Now onto gold.

Gold has been a real winner this year, surprising even the most active doomsday preppers.  Sure, gold rallies when things get rough and it has been a historic goto safe haven investment. It typically spikes when something bad happens, only to retreat quickly once the fickle markets move on from a news cycle, making it a tricky long-term position to hold for most fund managers.  This time it was different, the metal actually picked up a trend and continued to climb, reaching all-time highs as recently as Monday when it was up by +40% from its March low.  In yesterday’s session, gold raised eyebrows once again, falling by -5.69%.  The daily downward move, which is abnormally large for the commodity, could appear to be in response to recovery optimism in yesterday’s session, but gold is influenced by many other factors. On any given day the price of gold is influenced by demand for the physical metal for industrial purposes and for jewelry.  As supply is finite, increases in demand, which are cyclical in the case of industrial use and seasonal in the case of jewelry, cause the price of gold to go up. Other factors which impact the price of gold are the value of the dollar, inflation, and real yields.  I have discussed these in earlier market notes, but a quick review is in order.  When inflation is high, fiat currencies like the greenback lose real value, but gold does not, so investors buy gold in high inflation environments. Structurally, gold is traded in US Dollars, and when the dollar weakens against other currencies, it becomes cheaper to foreign buyers, increasing demand and price.  Finally, real yields are affected by bond yields and inflation.  When rates go lower and inflation is stable, investors seek gold.  The demand increases further when inflation is on the rise.  Rates are low and will be for some time.  Inflation is expected to increase once the economy turns around and consumers begin to ramp up demand for goods.  The dollar has been falling in response to an expanding deficit, real yields have been falling, and inflation, though minimal at current, is beginning to tick up.  With uncertainty abound, these factors explain gold’s recent performance.  In addition to the recovery optimism, yesterday’s fall in price is likely in response to bond yields ticking up (10-year yields popped by +7 basis points) which increases real yields.  It is too early to tell whether gold will lose its luster and continue to fall, but it is quite clear that the deficit is only going to get larger in the near term, inflation will continue to tick up, and bond yields are going to remain low for some time.  The allure of gold may not go away so fast, though it will be a bumpy road as investors ply the markets for alternative growth opportunities.

THE MARKETS

Stocks traded down yesterday as optimism was overshadowed by a selloff in technology shares.  The S&P500 dropped by -0.80%, the Dow Jones Industrial Average sold off by -0.38%, the Russell 2000 Index slipped by -0.60%, and the Nasdaq Composite Index gave up -1.69%.  Bonds dropped and 10-year treasury yields added +7 basis points to 0.64%.

NXT UP

- Consumer Price Index Ex Food and Energy (July) is expected to have ticked up by +0.2%, same as last month’s rise.

- Today’s Fed speakers include Rosengren, Kaplan, and Daly.

- Today’s earnings announcements include SmileDirectClub, Lyft, Vroom, and Cisco Systems.

daily chartbook 2020-08-12