The pullback last week feels and tastes very different compared to the slight four-day correction in the end of February. Back then, many of the leading stocks remained relatively unscathed and consolidated through time while the market averages briefly dipped below their rising 20-day moving averages. This time, the leaders of the past 6-month rally received a Mike Tyson’s punch in the face. The St50 index dropped 4.2%, while small caps lost 3%. These are notable signals of “risk-off” market behavior as momentum and small cap stocks typically lead on the way up and on the way down.
What else is different this time? Correlation. In February, all sectors pulled back together. Last week, the correction was a lot less indiscriminate. Large caps ($SPY, $DIA), healthcare ($XLV), retail stocks ($XRT) are holding a lot better. Utilities ($XLU) even managed to close at new 3-year highs.
It seems declining inflation expectations have been the major catalyst in the market over the past few weeks. Look at commodities. They have been decapitated – coal, iron, copper, corn, crude oil, you name it. People often forget that one sector’s rising costs is another sector’s rising revenue. The opposite is also true – one sector’s declining revenue is another sector’s declining costs. The market rarely forgets that and maybe this explains the notable relative strength in industries that are very vulnerable to inflation.
I already mentioned utilities closing at new 3-yr highs. Guess what, $XLU is also yielding 100 basis points more than Consumer staples ($XLP), so no surprise about the incredible positive action there in a world that is starved for yield.
Restaurants and casual eateries stocks are also acting extremely strong. Panera Bread ($PNRA), Ruth Hospitality Group ($RUTH), Dunkin Donuts ($DNKN), McDonalds ($MCD), Chuy’s Holsings ($CHUY) are near multi-year highs.
Retailers from all calibers are not too far behind them – $WSM, $WMT, $TJX, $M, $TSCO. REITs too – $GGP, $SPG etc. I guess that payroll tax increase didn’t hurt the American consumer propensity to spend, at least for now.
Is this just another sector rotation into defensive stocks or a sign of a lot more damage to come in the following weeks? It doesn’t hurt to be a little more careful. The consensus is that this is a garden-variety 5-10% correction within a bull market. Those happen at least a couple times every year and in hindsight look like good buying opportunities. It never feels comfortable buying the dips in real time though. And you don’t have to.
The silver lining of corrections is that they let future leaders form new bases. The biggest market “secret” is that from a long-term perspective, it has always been a “market of stocks” with very fat tails at both ends of the performance spectrum. The first stocks to make new 52-week highs after a 6-8 week correction are usually that the ones that will outperform significantly over the next 6 months.
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Have A Great Weekend!