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The S&P 500 has surged a remarkable 55% from the 23 March low – the fastest retracement in history. At this point, Lisa Shalett from Morgan Stanley expects to see some consolidation based on three examples of current market disconnects that seem particularly ominous for market health.

Key quotes

“Historically, year-over-year gains in the S&P 500 and changes in the Conference Board’s US Consumer Confidence Index match up. In fact, in the past 20 yers, the dispersion between the S&P and consumer confidence has never been this wide. The just-released headline confidence number fell to a six-year low, worse than the reading in April during the nadir of the economic shutdown. And the S&P reached a new all-time high of 3508 on August 28th. It’s now about 5% higher than the pre-COVID high in February and up 23% from this time a year ago.”

“An index of US economic surprises has reached a record, with the rebound in manufacturing and strong housing sales and durable goods orders all supporting our thesis for V-shaped economic recovery. But rather than seeing the rising tide lift all boats, correlations between sectors in the S&P 500 index are at an all-time low. Cyclicals and traditional value sectors are lagging market leadership, which is dominated by a small group of large-cap growth winners, mostly in tech. Financials, which typically perform well during economic rebounds, are languishing.”

“When Treasury yields fall, stocks in sectors that tend to be less volatile and offer high dividends usually outperform as investors seek ‘bond proxies.’ But lately, bond proxies, such as real estate investment trusts, utilities and consumer staples, have been left behind. Of course, commercial real estate has been hard-hit by the COVID-19 recession, but this dynamic still seems incongruous to me, especially given the outlook for continued low rates and weakness in financial stocks.”

“We encourage investors to look for opportunities where cognitive dissonance is loudest. We suggest waiting for a correction in the S&P 500, then moving into sectors that are lagging now, such as financials, industrials, materials and health care, which are likely to outperform once investors more enthusiastically embrace the V-shaped recovery that’s starting to emerge.”

 

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