Ping Pong Game Between Cyclical, Growth Stocks Continues

As the last full trading week of the first quarter comes to a close, it seems we’re seeing a continuation of the quarter-end rebalancing that has contributed to the ping pong game between growth and cyclical stocks.

In a familiar pattern, Nasdaq futures are lagging the other two main U.S. indices as a rising yield on the 10-year Treasury—which is up about 5 basis points this morning to start the day at 1.66%—casts some doubt on growth-company prospects. Rotation out of those stocks, including mega-cap tech-related names, has helped pave the way for investors to shift assets into stocks that stand to benefit from the economic reopening, such as travel, energy, materials and industrials companies.

While the market has been encouraged recently by the vaccine rollout in the United States, snags in Europe have kept that optimism in check and contributed to some of the volatility we’ve been seeing along with concerns that the economic recovery will end up coming with inflation.

The Fed, Inflation And Rates/h2

The latest inflation data, out this morning, showed that the core personal consumption expenditure price index came in as expected. The Fed’s preferred inflation gauge showed a monthly rise of 0.1%, in line with a Briefing.com consensus.

Despite the rise in the 10-year yield, the needle hasn’t moved on the Fed’s timeline for a potential rate hike. Federal Reserve Chair Jerome Powell’s soothing words this week in virtual Capitol Hill testimony may have threaded the needle between economic optimism and a reinforcement of its commitment to stand pat on rates. Futures markets are pricing in a 98% chance of no hikes this year.

While the rising rates haven’t been great for growth stocks, they’ve been steepening the yield curve, which tends to benefit banks by allowing them to earn more interest on loans.

Look for the Financials sector to potentially be a bright spot today, especially after the Federal Reserve said it would lift restrictions on buybacks and dividends starting on June 30 if they pass stress tests. While that pushes back an early announcement, bank investors still seemed to be encouraged on the news.

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Given the choppiness of the recent market, it was interesting to see the Cboe Volatility Index (VIX) fall below 20 yesterday. While it seems likely that choppy trade could continue, it seems that Wall Street’s main fear gauge is telling us that overall risk isn’t that great.

Supply Chain Headaches/h2

Energy companies could also stand to gain along with oil prices as it seems that the Suez Canal blockage may last for some time. The flow of crude deliveries has been hampered as tankers can’t get through the key waterway because a massive container ship is wedged across it.

In company news, Chinese electric vehicle maker Nio (NYSE:NIO) became the latest casualty of the global chip shortage. NIO said it would suspend production for five working days because of a lack of chips, joining other automakers that have had chip issues.

Now that automotive demand is heating up along with the economic recovery, car manufacturers like General Motors (NYSE:GM), Ford (NYSE:F), Honda (OTC:HNDAF) and Toyota (NYSE:TM) have warned the chip shortage is holding up production.

Turnaround Thursday/h2

Stocks yesterday staged quite a turnaround as early weakness amid pandemic worries gave way to economic optimism that helped the reopening trade.

It seemed that the market was able to shrug off comments from Powell, who told NPR that as the economy recovers, the central bank will be able to gradually unwind Treasury and mortgage-backed securities purchases.

Or maybe it wasn’t so much of a shrugging off as it was a refocusing on the glass-half-full scenario of the economy doing better, which Powell also pointed to because of fiscal stimulus from Congress and accelerated vaccine distribution.

Serving Up Economic Recovery/h2

Yesterday, the benchmark 10-year Treasury yield rose after a disappointing auction of 7-year notes, but the gains didn’t appear to cause the level of worries that we’ve seen from recent spikes in the yield.

Still, the higher yield may have contributed to selling in some big tech-related names that have come under pressure as rising inflation worries cast doubt on their valuations, which are based in part on future earnings potential.

That may have opened the gate to more buying in cyclical stocks that stand to benefit from the reopening. Airline and cruise companies did well. It seems like reopening trades are getting bought on their dips much more readily than mega-cap tech stocks.

In a vote of confidence for the economic reopening, Darden Restaurants (NYSE:DRI) rose more than 8% after earnings per share handily topped expectations and revenue also beat forecasts. The restaurant company also gave upbeat guidance as the vaccination rollout accelerates.

With the restaurant industry having gotten hit so hard during the pandemic, it’s good to see a recovery story—both for investors and those employees whose livelihoods depend on restaurant jobs. Darden also seems to be a case study in how corporate fortunes can recover along with the economy as the vaccine rollout takes hold.

CHART OF THE DAY: DOLLAR’S CHANNELING UP. Since January the U.S. Dollar Index ($DXY—candlestick) has been moving in an upward channel (yellow lines). The dollar is up a bit today and coming close to the top of the channel, which could act as a resistance level. Data source: ICE (NYSE:ICE). Chart source: The thinkorswim® platform . For illustrative purposes only. Past performance does not guarantee future results.

Across the Pond: As earnings season winds down, most European companies have reported fourth quarter earnings and ended up showing better performance than analysts had expected. The more than 90% of STOXX Europe 600 companies that have reported earnings have shown a 4% earnings-per-share decline year on year as they continue to be negatively impacted by the pandemic, FactSet said on Thursday. Although companies in Europe are lagging those in the United States, that earnings decline is a much better showing than the 16% drop analysts had been projecting back in September 2020. “While we saw a clear improvement across European companies in the final quarter of 2020, Europe is still struggling with negative growth compared to the S&P 500, which is showing slight positive growth year over year,” the FactSet article said.

Greenback Growth: Weaker corporate performance in Europe, a lagging economy, stumbles in the vaccine rollout, and a new wave of coronavirus cases are among reasons why the U.S. dollar has been ascendant. A stronger dollar is often an indication that the U.S. economy is doing well, at least in comparison to other countries. That appears to be the case now. Depending on where you fall in the inflation debate—either worried that the economic recovery will result in problematic price rises, or that an inflationary spike will be transitory—the higher dollar as a sign of economic progress can be encouraging or worrisome. But another thing to keep in mind is that the U.S. for the moment simply appears to be the best game in town for international inventors.

Global Ripples: Even if you don’t have any investments in Europe-based companies, the fate of the European economy is still likely to affect your portfolio if you hold stocks in U.S.-based multinationals, natural resources companies, and emerging market stocks. As a weaker European economy contributes to flows into the U.S. dollar, the stronger greenback could make U.S. goods more expensive abroad, dampening for U.S. exports. A rising dollar also puts pressure on commodities—as it did with oil, gold, and copper yesterday—by making them more expensive for holders of other currencies. That means producers like oil companies and miners could take a hit. And weaker commodities prices also mean that emerging market investments might not be as attractive. Those economies are often based on commodity exports, and they often have debt that’s denominated in U.S. dollars, which becomes harder to pay off as their own currencies dip and the dollar rises.

Disclaimer: TD Ameritrade (NASDAQ:AMTD)® commentary for educational purposes only. Member SIPC. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.

Written By: TD Ameritrade