Since the beginning of September, the markets have seen a correction driven by the large-cap tech names that have been such stellar performers during the COVID-19 crisis. After such a sharp run-up during the month of August, it’s not surprising that we should expect some giveback. Remember, stocks go up in bull markets – and they go down in bull markets. Sometimes we forget about this. But let’s take a look at a few things in order to provide some perspective.

Right on Cue
Seasonality shows that in this period of time during presidential election years, markets run into headwinds. Historically, those headwinds persist in a choppy market and tend to clear up in early October. Right on cue, we are following that historical roadmap.

Summer Strength Into Fall Volatility
Summer Strength Into Fall Volatility
Source: Natixis PRCG, Factset. S&P 500 Return Seasonality 1928-2019

What Lies Beneath
If we take a look at what is happening beneath the surface of the market, we find an interesting story unfolding. Despite headline index numbers, not everything is selling off. There are actually pockets of strength beneath the surface. With tech down almost 11% MTD through 9/20, you’d be somewhat surprised to note that materials and industrials are actually up for the month. Several other economically sensitive sectors are doing just fine, and small-caps – the most sensitive to risk appetite – are off only fractionally.

Summer Into Fall Performance
Source: Natixis PRCG, Bloomberg. Performance(08/31/20-09/18/20)

Mind the Tech Rotation

Tech makes up roughly 24% of the S&P 500® these days. Materials and industrials? Well, just 2% and 8% respectively. So when we see a rotation out of a sector that is 24% of the index and into two smaller sectors that combined account for 10% of the S&P 500®, the weightings impact can have an outsized effect on the headline index return. Tech has been garnering all the attention lately, but investors should not forget that the US economy isn’t just tech and that the S&P 500® has other components besides tech. Those other components have been quite strong despite what the headline index level is implying.

Cyclical Stories
Take a look at some of the other cyclical sectors of the market. Base metals, for example; copper, steel, all the ingredients that are needed for things that we build. Take a look at construction equipment manufacturers and shipping companies. These companies are highly sensitive to the economic cycle and many are showing strength relative to the overall market. Why do we point this out? Because if this were a downturn driven by economic fundamentals weakening, you’d expect the economically sensitive segments of the market to lead us lower. But instead, we are really only seeing tech head down. And it certainly seems that the move in tech is simply a rotation into the more cyclical areas of the markets. If the weakness continues to spread into these other areas, that bears watching and we will certainly take note.

In Other News
Recent events in the news haven’t been particularly great for overall market sentiment, either. Headlines include the spike in COVID cases abroad and the possibility of another lockdown in the UK, money laundering allegations against European banks, and the Bank of England potentially moving towards negative interest rates. In the US, Supreme Court Justice Ruth Bader Ginsburg’s death also shifted the focus of Congress from possibly negotiating an additional COVID-19 support package for the unemployed to pushing through a replacement justice before the November election. This probably all but puts the nail in the coffin of a fiscal package before the elections.

Now What?
Something for everyone. While focusing on the headline index certainly provides some sense for a pause in risk assets, there remains a much different story unfolding beneath the surface. As they say, it’s a market of stocks and not a stock market. While we still are in the camp that we are in the midst of a rotation from a large sector of the market into some of the cyclically sensitive laggards, we are on watch for a broader theme of weakness should it develop. Rotations are a healthy sign in a bull market. Consolidation should be expected, especially in some pockets that have seen impressive gains. But until we see that weakness spread to other parts of the market like the cyclically sensitive ones, we continue to remain optimistic. What lies beneath the surface is much more important.
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