Reopening Stocks Look Too Fragile To Carry The Market

My narrative since August has been “Rotation or Bust.” With reopening trades outperforming the past month but the overall market lower, it’s looking more like Rotation And Bust. The Covid-driven tech trade is once again unwinding and a single misstep by Congress could pull the rug out from the market in a hurry.

As the Delta wave peaks and we trend away from the Covid regime, we also trend away from the major market catalysts behind the 18-month Crisis Bull Run. Those have been 1) tech adoption rate 2) low interest rates and 3) nothing else to do but trade.

It also means the well of stimulus is running dry. The reality is that stimulus has been drying up for months as the rate of liquidity coming into the economy peaked in the first quarter. The timing of that peak aligns perfectly with the beginning of the bear market in speculative growth trades embodied by the ARKK fund. Unless there’s a stimulus deal that hasn’t already been priced in, we’re walking into a liquidity vacuum as both the rate of new spending slows and interest rates rise.

If the economic backdrop were ideal, this scenario might be palatable for investors able to catch the rotation in its nascent stages and safely hop from one trend to the next. But with inflation looking sticky and consumer confidence retreating, we’re not on solid footing. Reopening trades are beating work-from-home stocks the past month, but are doing it in a down market. So the rotation happening is so far net-positive for passive index owners, and it’s going to take a lot to change that.

That’s because reopening trades got really expensive this year, even after their summer pullback. In February I ranked S&P 500 companies in order of how much their price-to-sales valuation ratio increased over the past year. it was a remarkably good predictor of which stocks would be punished as interest rates spiked. Tesla, Enphase Energy, PayPal and Nvidia all topped the list and all dropped at least 20% over the next month. That same screen today gives quite a different result: it’s cruise lines, Live Nation, and hospitality stocks whose valuations look the most inflated.

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The market is already undergoing a stinging reminder that beating Covid comes with a big side effect: higher interest rates and the unwind of speculative madness. Tack on literally anything else — like higher taxes or a botched infrastructure deal — and the stock market could be the haymaker follow-up to 2020’s gut-punch.

For bulls looking for an out, you have to hope Friday’s PCE print comes in softer than expectations. Inflation is still at the core of the bear thesis, so any positive surprise there should give the market a reason to bounce.

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