Equities Markets Might Face More Downside Going Into October

Summary

• For the fourth consecutive week, equity markets closed on the red.
• U.S equities saw 25 billion in outflows, the most since March, and the high yield credit market had an outflow of 4.2 billion in the last six trading sessions.
• The catalyst seems to be worries about the recovery and potential for a double-dip recession. This week's economic data shows that the economy is currently pivoting into a slower recovery.
• Fed bond purchase activity appears to be on the rise; however, the Fed commitment to keep strong asset prices will be challenging without the stimulus.
• My views from last week have changed; credit market stress, the excessive bullishness toward tech stocks, and the constant hearing about this pullback being a "healthy correction" are giving some signal we should expect more downside going into October. NYFANG index breaking it's 50-day moving average might trigger a downtrend.

For the 4th consecutive week, Dow Jones and S&P 500 closed on the red: Dow Jones lost 1.8% to 27,124, and the S&P 500 lost 0.6% to 3298. On the other hand, the Nasdaq closed on the green, snapping a 3-week losing streak: Nasdaq climbed 1.1% to 10,914 (Figure 1). A curious outperformer this week was the technology sector, followed by utilities and Cons. On the other hand, discretionary, Energy, Financials, and Materials were among the worst performers (Figure 2).

Figure 1: U.S Major Indices Week Performance

Source: KOYFIN

Figure 2: US Sectors Week Performance

Source: KOYFIN

This week, we saw that companies with profits most closely tied to economic growth like banks and materials led to the drop. The rotation from growth to value faltered along with the recovery trade as investors' concerns about the economy worsened. As shown in Figure 3, airlines, hotels, and restaurant indexes have declined significantly, and as shown in Figure 4, the rotation from growth to value stocks faltered this week.

Figure 3: Airlines, hotels and restaurant Indices

Source: Bloomberg LLP

Figure 4: Growth vs Value week performance Source: KOYFIN

Investors are concerned that the economy would falter without another stimulus, enduring the rebound in corporate profits. As a result, investors are piling up into the tech sector, which has demonstrated some safe-haven qualities in the last months as it has been outperforming during market sell-offs.

This week economic data signal that the economy is currently at a tipping point without further stimulus

Economic data continues to stall. Our primary financial data are: the initial jobless claim on Thursday and the Durable goods orders report on Friday. According to the Labor Department, U.S initial jobless claims increased by 4,000 to 870,000 in the week ended September 19 prior, reporting figures well below market expectations of 840,000.

According to the Commerce Department data, U.S orders for durable goods increased in August by 0.4% from the prior month after an upwardly revised 11.7% jump from July. Durable goods are above pre-pandemic levels; however, the August number is well below market expectations of a 1.5% increase, signaling that the economic recovery is slowing.

In conclusion, this week's economic data shows that the economic recovery has stagnated, raising the potential for a double-dip recession. Jobless claims show the labor market deteriorating, and the durable goods below expectations numbers show stagnation. In the last few weeks, we have seen economic data slowing, very similar to what happened in Mid-June; however, this time, fiscal stimulus is missing. Recent financial data reflects that the recovery is uneven across the economy as it has slackened in many areas. Also, Coronavirus cases globally are on the rise again, especially in Europe. A second fiscal stimulus is looking very unlikely, increasing the likelihood of a further decline in U.S equities.

Investors' risk appetite is worsening, U.S equities and high yield credit market reports record outflows.

According to the Bofa strategist citing EPFR global data, in the week through September 23, the equity market saw $22.8b of outflows, the most since March. $1.3 went into the bond market, and $1.4 went into gold. Strategists led by Micheal Harnett said that we shouldn't expect big bears; they see a correction as "healthy" rather than dangerous, as the widening of credit spreads didn't emerge. However, credit spreads did rise in the last six trading sessions, signaling stress in the credit market. According to Bloomberg League tables, high yield corporate bonds sales in the U.S fell 68% to 6.36 billion for the week ending September 25 vs., while benchmark index spreads increased 47 basis points. Furthermore, the high yield ETF had net outflows totaling $4.26 billion as high yield bond spreads jump at last (Figure 5).

Figure 5: HYG Etf fund flows and Bloomberg Barclays U.S corporate High Yield Average Index

Source: Bloomberg LLP

Fed bond purchase activity appears to be on the rise.

The Federal Reserve bought $21.3 billion of Treasuries in the week ended September 25, the most market risk purchased since the week ended on August 21 (Figure 6). Fed announced it would be buying about $80 billion of Treasuries over the month ending October 14. It will be interesting how the Fed commitment to keep risk asset prices strong plays out without a fiscal stimulus.

Figure 6: Fed breakdown of week purchases

Source: Bloomberg LLP

The current market correction might be only halfway done.

It appears that the current tech-led sell-off in U.S Equities is likely halfway done, according to Morgan strategist. The Nasdaq is currently at a correction of 12% tumbling below it's 50-day moving average. Yet despite the losses, we continue to see market speculation. According to Mike Wilson, Morgan Stanley chief U.S equity strategist on a Bloomberg News article, excessive bullishness toward tech stocks has yet to be completely washed. Despite the worst drawdown in months, we saw record inflows into the 3x leveraged ETF (TQQQ) and the snowflake IPO more than doubling on its first day. As shown in Figure 7, Nasdaq might be hitting it's 200-day moving average.

Figure 7: Nasdaq 100 and it's 200-day moving average

Source: Bloomberg LLP

Conclusion

For the fourth consecutive week, equity markets closed on the red. This week we saw considerable outflows in U.S equities and the high yield credit markets. U.S equities saw 25 billion in outflows, the most since March, and the high yield credit market had an outflow of 4.2 billion in the last six trading sessions. The technology sector appears to be a safe-haven asset in this sell-off as it outperforms. The catalyst seems to be worries about the recovery and potential for a double-dip recession. This week's economic data shows that the economy is currently pivoting into a slower recovery. U.S fiscal stimulus progress continues to stall, reinforcing my view of no stimulus before the November 3 elections. Fed bond purchase activity appears to be on the rise; however, the Fed commitment to keep strong asset prices will be challenging without the stimulus. My views from last week have changed; credit market stress, the excessive bullishness toward tech stocks, and the constant hearing about this pullback being a "healthy correction" are giving some signal we should expect more downside going into October. NYFANG index breaking it's 50-day moving average might trigger a downtrend.