Technology stocks lead market lower as S&P 500 falls over 2%

What to do when the market goes down? Read the opinions of the investment gurus who are quoted in the Wall Street Journal. And, as you read, laugh. We all know that the pundits can’t predict short-term market movements. Yet there they are, desperately trying to sound intelligent when they really haven’t got a clue. – Jonathan Clements

It was the late Louis Rukeyser who said that trees don’t grow to the sky in a reference to the fact that stocks can also trade lower and don’t always go up. Investors might have thought otherwise recently as the S&P 500 Index posted its fifth straight monthly advance in August, rising nearly 60% since its intraday low back on March 23rd. That notion was dismissed last week as the stock market turned south on Thursday and ended the week with losses in all of the major averages. The biggest loser was the technology-laden Nasdaq Composite Index, which had soared to an all-time closing high above 12,000 on Wednesday only to see those gains partially vanish on Thursday and Friday with losses of over 6%. It’s difficult to pinpoint a reason for the sell-off but a number of pundits tried. Some of the possibilities included blaming the Federal Reserve for keeping interest rates lower for longer, fears about the upcoming election, worries that a vaccine would not be ready by years-end and failure of Congress to pass another economic relief bill. While all of these reasons are plausible, the most obvious explanation is the simple fact that the stock market, particularly stocks in the technology sector, had become expensive and overvalued. The S&P 500 Index is a market-capitalization weighted index and technology stocks have dominated the top spots in the index through their outsized performance relative to other stocks in the benchmark. The technology sector traded at nearly 28 times forward earnings and many of these stocks had become too popular and over owned. Investors simply took profits in a sector and a market that had come too far and too fast and was overdue for a pullback or a correction. Low interest rates can make expensive stocks such as technology names look undervalued, but the disparity between growth stocks and value stocks had become too wide for investors to ignore. Lost in the market turbulence last week was the August employment report, which was actually better than expected as 1.37 million jobs were created and the unemployment rate fell to 8.4%, down from 10.2% in July.

Last Week

The ISM manufacturing index in August rose for the fourth consecutive month and reached a 21-month high as its strong reading was decidedly expansionary. The ISM non-manufacturing or services sector index slipped from its level in July but was in line with forecasts. Concerns continue over the coronavirus pandemic but there is still optimism about business conditions and the economy as businesses continue to open.

The Federal Reserve’s Beige Book, a regular survey of the economy, showed that the economy expanded in August but that lingering anxiety over the coronavirus led to slower growth. Total business and consumer spending is still below pre-crisis levels.

For the week, the Dow Jones Industrial Average fell 1.8% to close at 28,133 while the S&P 500 Index declined 2.3% to close at 3,426. The Nasdaq Composite Index dropped 3.3% to close at 11,313.

This Week

It will be a relatively quiet week for economic data as both the producer price index (PPI) and the consumer price index (CPI) for August are expected to increase modestly, with the CPI posting a year-over-year increase of 1.2%.
The European Central Bank (ECB) meets to review its monetary policy and is expected to leave its benchmark interest rate unchanged at a record-low negative 0.5%.

This will also be a quiet week for quarterly earnings as Lululemon Athletica, Peloton Interactive, Navistar International, Oracle, Casey’s General Stores and Kroger are the most prominent companies scheduled to report.

Portfolio Strategy

Despite the losses in the stock market last week, stocks are up over 50% since their intraday low on March 23rd and the S&P 500 Index has posted a year-to-date total return of 7.5%. The market’s decline on Thursday and Friday is a reminder to investors that there are risks in owning stocks and sentiment can change quickly. Technology stocks had led the way as many of these companies seemed impervious to the economic slowdown and actually benefited from the coronavirus pandemic and the shelter-in-place rules. But their lofty valuations were being fueled by momentum as traders were simply buying these stocks on the assumption that they would go even higher. Last week’s losses in technology stocks were reminiscent of the bursting of the dot-com bubble in 2000, but there are important differences between then and now. Back then, many of the internet stocks had little or no earnings and were trading at nosebleed valuations that defied explanations. While many technology stocks today are expensive, these companies have sustainable earnings that should support their stock prices over time. Also, the Federal Reserve had just raised the federal funds rate in 2000 and the yield curve became inverted, a telltale sign of tighter monetary policy and a likely slowdown in the economy. Oil prices had doubled, too, and were much higher than they are today. By contrast, the Federal Reserve has lowered interest rates to zero this year and has expanded its balance sheet in an effort to provide liquidity to help jump start the economy. Although the market is still trading at an above-average price earnings ratio, it should gradually recover over the next few months as interest rates remain at historic lows and there is still a lot of money on the sidelines in money market funds that could be used to buy stocks.