Avoiding the Hangover

By David Nelson, CFA CMT

They say a picture is worth a thousand words. The graphic below tells a lot about the mental state of U.S. investors. No one wants to leave the party but at the same time they don’t want to wake up in the morning with a hangover. In that mindset investors have clearly gotten more defensive moving into higher quality and shedding some of their more speculative bets.

The FactSet data above shows some of the largest ETF redemptions Friday were in Direxion Daily Financial (FAS) and Technology (TECL) Bull 3x levered shares. On the other side of the ledger leading creations were SPDR S&P 500 ETF Trust (SPY), HealthCare Select Sector SPDR Fund (XLV) and iShares 20+ Treasury Bond ETF (TLT). Net flows were generally positive for the week showing investors aren’t necessarily raising cash just cutting their beta exposure.

Data by FactSet

The 500k miss in non-farm payrolls earlier this month weighed on investor sentiment all week. Caught off guard investors spent last week repositioning or churning more than wholesale asset dumping.

Several times during the week bulls attempted to rally the markets and get back on course but each attempt was met with selling the worst of which was Friday’s meltdown into the close. A (-1.7%) decline in the S&P 500 is hardly a breakdown especially sitting less than 2% from all-time. Nevertheless, traders and investors felt the unease as they headed into the weekend.

Data by FactSet

With the S&P up close to 20% YTD the urge to lock in looms large and any further deterioration will likely trigger a more accelerated downturn. Clearly markets need a catalyst. Of course, catalyst can be good or bad. Estimate revisions to the upside have started to slow but are still heading in the right direction. GDP estimates for the current quarter have come in but much of that has been added to Q4. The earning’s season is more than a month away so the next trigger good or bad is going to come from a different battle front. The financial news cycle will focus on Covid, Washington, China, economic data, inflation along with your favorite and mine the Fed.


COVID – Covid data may be peaking but any further deterioration will be met with negative estimate revisions and stocks will be quick to discount the coming bad news. CDC reports that the 7-day moving average of daily new cases decreased 12.7% compared with the previous 7-day moving average. However, the 7-day moving average is 99.3% higher than the value observed approximately one year ago…

Data from CDC

The Infrastructure Package – Whether you buy into to the traditional definition or today’s human infrastructure variant a package is coming. Given Senator Joe Manchin’s resistance to the Democrat’s current $3.5 Trillion package it is likely we will see a scaled down version. With just a 3-vote majority in the house and zero wiggle room in the Senate it is unlikely to pass in present form especially since Speaker Pelosi has promised a vote on the bi-partisan bill by September 27th. What’s in the bill may matter less than how they are going to pay for it. Goldman’s Jan Hatzius says in a recent note they believe markets have priced in a 62% chance of a statutory corporate rate hike.

As of Sunday evening the Wall Street Journal is reporting the Democrats are eyeing a 26.5% Corporate Tax Rate and imposing a 3% surtax on individual income above $5 million. 

The Debt Ceiling – As reported in the Wall Street Journal Secretary of Treasury Janet Yellen said her agency may run out of room to keep paying government’s bills on time during the month of October, unless Congress lifts the federal borrowing limit… We’ve been here before and like every other time Washington will give into reality and raise the limit. The good news is that Speaker Pelosi has said Democrats are unlikely to include a debt-ceiling increase in a $3.5 trillion reconciliation bill. That of course would meet stiff resistance from the GOP.

Powell – The Fed Chair’s term ends in February but inside the beltway most Washington pundits believe Jay has the nod from President Biden and will continue to lead the Fed. The progressive side of the party led by AOC and others have told the President “…it’s time to reimagine the Federal Reserve.” The Fed has already expanded well beyond its original dual mandate. I think it’s safe to say any wholesale change would force fixed income markets to reprice. The contagion would spread to other asset classes very quickly.

A very heavy week on the economic calendar will likely drive most of the equity action this week. Given the record PPI number we saw last week Tuesday’s CPI (Consumer Price Index) looms large. If inflation is indeed transitory just how long will the Fed defend the status quo before they are forced to act.

*At the time of this article some funds managed by David were long SPY and TLT