Tech stocks lead market lower for second straight week

I can’t recall ever once having seen the name of a market timer on Forbes annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it. – Peter Lynch

For the second consecutive week, all of the major stock averages suffered losses with the brunt of the selling pressure occurring in the technology sector. The biggest loser was the technology-heavy Nasdaq Composite Index, which dropped over 4%, bringing its losses over the last two weeks to more than 7%. In the three trading days that included Tuesday and Thursday and Friday of the previous week, the Nasdaq experienced the fastest correction of 10% in its history. To put this loss in perspective, though, this index had risen over 60% in less than six months from its March bottom. The broad-based S&P 500 Index has fared better the past two weeks with losses of less than 5% and it is still positive on a year-to-date basis. As in the previous week, there were no catalysts for the sell-off other than the fact that mega-cap technology stocks were overbought and due for some profit-taking. If investors had to place blame for the weakness in stock prices at something, it easily could have been Congress, which had returned to Washington after a lengthy recess but failed once again to pass another economic relief package. A Senate relief bill that proposed $650 billion was defeated as there seemed to be no sense of urgency like there had been when the first bills were passed. With both Republicans and Democrats still far apart on the amount of additional stimulus that is needed, it now appears that there may be no deal before election day. In the meantime, there were no significant economic reports or corporate earnings announcements with the potential to move markets last week and that will also be the case this week as second quarter earnings season has ended. In this scenario, markets may struggle to find direction as there are conflicting forces between abundant Federal Reserve liquidity and an improving economy on the one hand and continued uncertainty over the virus and elevated equity valuations on the other hand. After the strong stock market rally since March, the market may be in for a period of consolidation and trade sideways over the near-term.

Last Week

The producer price index (PPI) in August was higher than expected but lower than in the previous month and has barely risen in the 12 months through August. The consumer price index (CPI) was also higher than expected in August and most of the increase was due to a spike in the cost of used cars and trucks. Inflation remains low, however, as the CPI has increased only 1.3% over the past year. Inflation is well below the Federal Reserve’s 2% target and should allow the Fed to keep interest rates low for at least the next year or two. The weekly jobless claims were 884,000, which were more than forecast. Although recent claims have been better than expected, economists worry that a resurgence of the virus in the fall could affect the progress that has been made.

For the week, the Dow Jones Industrial Average fell 1.7% to close at 27,665 while the S&P 500 Index declined 2.5% to close at 3,340. The Nasdaq Composite Index dropped 4.1% to close at 10,853.

This Week

Retail sales in August are expected to increase more than in July and August housing starts, though slightly less than in July, should still be solid as they have rebounded strongly from their low in April. Leading economic indicators for August should be in line with those in July but the pace of the increase has slowed, indicating that economic growth may be faltering. The preliminary University of Michigan consumer sentiment index for September is forecast to be slightly higher than in August.

The Federal Open Market Committee (FOMC) meets to review its monetary policy and is expected to leave interest rates near zero.

The only notable companies scheduled to report earnings this week are Lennar, Adobe and FedEx.

Portfolio Strategy

The most important event this week will be the Federal Open Market Committee (FOMC) meeting, which is the last such meeting before the election. Most analysts expect the Fed to remain accommodative by leaving the federal funds rate unchanged near zero and to reassure the American public that it will do whatever it takes to help support the economy. It will also update its economic and interest rate outlook for the future, which will likely include no rate hikes until 2022 at the earliest. The Fed’s near zero interest rate policy has left Treasury yields at historic lows with the 2-year Treasury yielding only 0.13% and the 10-year Treasury yielding just 0.67%. These paltry yields provide investors with very little income but the decline in interest rates this year has given investors a decent total return as bond prices have risen. (Bond prices and yields move in opposite directions). Going forward, it will be much more difficult to realize gains in bonds as the Fed has indicated it will let inflation run above its 2% target to achieve an average rate over time. Higher inflation reduces the value of bonds, especially those with longer maturities. The Fed has also frowned on using negative interest rates as a monetary policy tool. With rates already at rock bottom levels, any potential gains from rising bond prices would be limited. For these reasons, investors should avoid bonds with long maturities or high duration, which measures the price sensitivity of a bond to interest rate changes. There is a greater likelihood that interest rates will rise and not fall since they really can’t fall much further without going negative. Investors are not properly compensated for the risk of interest rates rising by owing longer-term bonds. Fixed income portfolios should be structured with mutual funds or exchange-traded funds (ETFs) that invest in shorter-dated bonds that limit any price erosion in the event that interest rates eventually rise.