Homebound? Stocks had a mixed close yesterday, held back by hard-to-ignore warnings from governors and mayors that dining out may once again be limited. The Senate inched yet closer to a stimulus deal, raising the odds of a package within December.
N O T E W O R T H Y
Risky business. Stocks had a bit of a sluggish day yesterday, reversing the optimistic themes that prevailed for much of the past month. A rush into cyclical and value stocks was pushed aside for easy-to-own tech and gold. The biggest losers lunch table included those spritely-of-late energy stocks, rarely popular materials, and the fickle financials. The recent rise in those sectors was primarily driven by three weeks of good vaccine news and lawmakers agreeing to agree on some sort of much-needed economic stimulus. Yesterday, we were treated with a rare show of confidence amongst lawmakers that they may actually agree on a stimulus package within the month. We also heard that the UK would start vaccinations today. WHILE YOU SLEPT, they made good on the promise as they begin to jab (that’s British for inject) their first wave of recipients. All of this good news, one would suspect, would have been cause for a celebration in the stock market, but it was not to be. I have introduced you to the concept of “buy the rumor, sell the news” in past notes, and this appears to be one of those cases. The fact is that the markets have largely already factored in a vaccine and a near-term stimulus package. Yesterday’s moves were most likely due to dollars seeking better opportunities. Since November 1st, the energy sector rose by an eye-watering-for-energy +39.72% as of Friday’s close, while the tech sector only added a downright-muted-for-tech +13.61%. That put technology shares in a rare moment of relative value, hence the potential motive for a rotation. Speaking of value, one way that analysts view value is through equity risk premium. The risk premium is the difference between the return on a risk-free asset (10-year treasury) and the expected return on stocks. Equities are clearly more risky than Government backed bonds, so one would expect to get better returns for taking on more risk… risk premium. When that risk premium gets too high, equities are said to be rich, and they typically pull back as the premium reverts to the mean. Conversely when the premium is lower, stocks tend to rise, as they are said to be cheap. There are many ways to calculate the expected return on stocks. One of the most common is by using forward PE multiples (that means next year’s PE). The S&P500’s forward PE is around 22 right now. Though, you may think that is high, it is actually right around average for the past few years. Based on the forward PE of 22, we can expect returns of 4.55% (the inverse of the PE). If we subtract the risk free 10-year treasury yield from that, we get a risk premium of around 3.6%, which is just about normal for the index. So, for many value-based investors the index appears to be neither too rich nor too cheap, but, rather, just right.
THE MARKETS
Stocks had a mixed close yesterday as traders took notice of the rising COVID cases and the subsequent threat of localized lockdowns. The S&P500 sold off by -0.19%, the Dow Jones Industrial Average dropped by -0.49%, the Russell 2000 Index slipped by -0.06%, and the Nasdaq Composite Index advanced by +0.45%. Bonds advanced and 10-year treasury yields gave up -4 basis points to 0.92%.
NXT UP
- This morning, NFIB Small Business Optimism (Nov) showed that optimism slipped to 101.4 from 104.0, missing consensus estimates.
- Thor Industries and AutoZone beat estimates earlier today and we will hear from GameStop and Chewy after the closing bell.
- Lots of focus will remain on the upcoming IPOs expected from DoorDash and Airbnb, both gaining lots of attention (and cost).