Mildly concerning vaccine data and other headwinds weighed on the markets on Thursday as the indices closed mixed.

News Recap

• The Dow Jones closed up 86 points, or .29% after rising over 200 points at the session high. After closing at record highs for two straight sessions and hitting another intraday high, the S&P 500 pulled back .06%. The Nasdaq rose 0.23%, and small-caps once again led the way with the Russell 2000 gaining .60%.
• Reports that Pfizer was scaling back its vaccine rollout plan for 2020 due to supply chain issues weighed on markets. After finding raw materials in early production that did not meet its standards, Pfizer now expects to ship out only half the vaccines it planned to ship in 2020. However, Pfizer and BioNtech are still on track to roll out 1.3 billion vaccines in 2021. Pfizer’s stock fell 2% on the news.
• Jobless claims from last week came in at 712,000 and beat estimates of 780,000. This is the first time in 3 weeks that jobless claims fell, and was the lowest figure since the pandemic started.
• US job cuts also slowed in November. 64,797 job cuts were reported in November, a drop from the 80,666 cuts in October, and the second-lowest monthly total for 2020. However, it is 45.4% higher than the 44,569 cuts in the same month last year.
• The ISM Non-Manufacturing PMI, or indicator for the U.S. services industry, fell to 55.9 in November from 56.6 in the previous month, and was largely in line with estimates. However, this reading is the slowest increase in the services sector in six months.
• House Speaker Nancy Pelosi and Senate Majority Leader Mitch McConnell spoke for the first time since the election and discussed the stimulus package. McConnell on Wednesday rejected a $908 billion bipartisan proposal but said that he sees “hopeful signs” toward reaching an agreement by the end of the year.
• Further stroking the flames of tensions with China, the House of Representatives unanimously passed a bill that willmandate Chinese companies to adhere to U.S. auditing standards if they want to be listed on American exchanges. President Trump is expected to sign the bill into law.
• COVID-19 continues to rage at alarming numbers. Over 100,000 patients are currently hospitalized. The initial wave in the spring never came close to this. 2,800 COVID-19 deaths were also reported- the highest single-day death toll on record.

In the short-term, there will be optimistic days where investors rotate into cyclicals and value stocks, and pessimistic days where there will be a broad sell-off or rotation into “stay-at-home” names. However, in the last two sessions, markets largely traded sideways.

In the mid-term and long-term, there is certainly a light at the end of the tunnel. Once this pandemic is finally brought under control and vaccines are mass deployed, volatility will surely stabilize, and optimism and relief will permeate the markets. In fact, CNBC personality Jim Cramer said that beating COVID-19 would feel like “the end of prohibition.” Stocks especially dependent on a rapid recovery and reopening such as small-caps should thrive.

Markets will continue to wrestle with the negative reality on the ground and optimism for an economic rebound in 2021. While more positive vaccine news continues to trickle in day by day, there is still discouraging COVID-19 news, economic news, and geopolitical news to consider. Amidst the current fears of a double-dip recession with further COVID-19-related shutdowns and no stimulus, it is very possible that short-term downside persists. However, it’s encouraging that Pelosi and McConnell are talking again. If a stimulus passes before the end of the year, it will certainly boost sentiment.

Due to this tug of war between good news and bad, any subsequent move downwards will likely be modest in comparison to the gains since the bottoms in March and since the start of November. It is truly hard to say with conviction that another crash or bear market will come. If anything, the constant wrestling match between sentiments will keep markets relatively sideways.

Therefore, to sum it up:

While there is long-term optimism, there is short-term pessimism. A short-term correction is very possible. But it is hard to say with conviction that a big correction will happen.

This morning’s premium analysis will showcase the “Drivers and Divers” of the market. I will break down some market sectors that are in and out of favor. Dear readers, do me a favor and let me know what you think of this segment! Always happy to hear from you.

Driving

Materials (XLB)

The materials sector, as represented by the XLB ETF, has been one of the largest beneficiaries of the vaccine rally. Investors have been so bullish on materials and any resulting vaccine prospect, that the XLB ETF briefly touched on its 2020 high the other day. However, it has pulled back a bit from this high, making it somewhat more attractively valued. But some things in this chart are concerning for me.

Cyclical sectors such as materials are set to be the biggest winners from an economic reopening in 2021. However, the ETF’s volume has plummeted and there are simply not enough strong fundamentals to justify calling this a BUY. For the materials ETF to come back, exceed its 52-week high, and pierce that $72.33 resistance level, a COVID-19 vaccine must be safe and scalable, and the 2021 economic outlook must be positive. If this happens and a double-dip recession can be averted, then materials will surely boom further. But for the time being, there is too much uncertainty to make a conviction call. Therefore, this is a HOLD for the short-term, however, I am considerably more bullish on materials in the long-term.

Financials (XLF)

Financials performed strongly in November and have started December off strong as well. With optimistic sentiment on businesses fully re-opening in 2021, banking stocks have surged. Furthermore, higher quality loan applications have fueled the rally.

But buyers beware. Interest rates are still at unprecedented lows and will not change until possibly 2022-2023. Interest rates are a huge driver of banking revenue, and until these rates start rising again, profit margins will continue to narrow.

Despite low interest rates that may or may not eventually turn negative, there is a positive tailwind that could push banking stocks higher - the influx of new investors and new money in the markets. There has been such a glut of new retail investors with a fear of missing out on the rallies, that certain big investment bank stocks have seen record growth.

I worry about overheating with this sector though; judging from its RSI, the decline in volume, pricing position relative to its moving averages, and proximity to its 2020 high. Without rising interest rates, it’s hard to fully justify the gains.

The theme of mixed sentiment continues for this sector. However, because so much of the sector’s revenue depends on interest rates, and those will not go anywhere for at least the next year or two, I have this at a SELL. Take the profits while you can!

Energy (XLE)

Largely fueled by holiday travel, and optimism that fuel demand could return to normal levels in 2021, energy was by far the best performing sector in November. However, it has somewhat pulled back to start off December. There are still simply too many headwinds to be overly euphoric. However, on Thursday, oil prices rose more than 1% and traded as high as $45.83 a barrel after OPEC+ finally agreed to a small oil production hike from January by 500,000 bpd.

Additionally, while energy is still largely undervalued, nobody truly knows what oil’s long-term prospects are with the increased adoption of renewable energy.

We have seen this year that when energy rallies, it eventually pulls back. Judging from the chart, we may have hit that inevitable pullback yet again. While there is vaccine optimism now that there wasn’t before, conditions are largely the same on the ground with regard to COVID-19 and travel demand. Therefore, my call is to take profits and SELL.

Small-Caps (VSMAX)

Small-caps were the biggest winners in November outside of energy. What makes this market rally different from the one in April/May, is that small-caps and cyclicals have led the way rather than tech. This is a bullish sign for an economic recovery and shows that investors are optimistic that a vaccine will return life to more normalcy in 2021.

However, when looking at the chart, it becomes pretty evident that small-cap stocks have overheated in the short-term. These are stocks that will “sell the news” more so than other stocks, and experience more short-term volatility. I would HOLD in the small-term, and maybe take some profits if you can - but do not fully exit these positions. BUY for the long-term recovery on a pullback.

Diving

US Dollar ($USD)

The US Dollar continued its long decline on Thursday. It continues to trade at a 2.5 year low, and could fall further due to a multitude of headwinds.

If the world returns to relative normalcy within the next year, investors will continue to be more “risk-on” and less “risk-off,” which means that the dollar’s value will inevitably decline further.

While it is too early to proclaim that the dollar’s decline is the “demise of the world’s reserve currency,” all of the economic stimulus combined with record low-interest rates will hurt the dollar’s value in both the short-term and long-term. Another stimulus package is imminent either by the end of the year or in 2021 and will cause more declines in the dollar’s value as well. Strategists at Goldman Sachs predict a further 6% decline over the next 12 months, ING analysts forecast as much as a 10% drop, and most notably, Citigroup predicts a shocking 20% drop in 2021.

This plunge is concerning both in the short-term and mid-term for the US economy, as a declining dollar means a strengthening of other foreign currencies such as the Euro or Yuan. Although US Treasuries have somewhat recovered, this could mean bad things for their values as well.

The plunge of the dollar has been so severe that it is currently trading below both its 50-day and 200-day moving averages. Furthermore, its 200-day moving average is considerably higher than its 50-day, further illustrating the sharp decline.

While the dollar may have more room to fall, according to its RSI, it is now officially oversold. This may be a very enticing opportunity to buy the dollar at a very attractive discount. However, do not be fooled. Based on all the headwinds and data, the dollar’s fall may be nowhere close to finished.

For now, where possible, HEDGE OR SELL USD exposure.

Communication Services (XLC)

Communication services have not rallied as much as other sectors. The ETF declined on Thursday and continues to trade relatively sideways. There are serious overvaluation concerns, as its RSI indicates that it may be nearly overbought. The decline in volume has also been sharp and swift. For the long-term, communications stocks have largely underperformed other sectors as well. It’s hard to foresee how this sector will truly benefit from a vaccine rally relative to other sectors, therefore, I give it a SELL call.

Health Care (XLV)

Healthcare should in theory benefit from a vaccine, however, it continues to be one of the market’s biggest underperformers. Although a vaccine will cause short-term surges in companies that are directly involved in vaccine production and distribution, it will not be a long-term profit driver for these companies. Additionally, the vaccine will only benefit a few companies while the rest of the sector lags. The pandemic has caused hospitals and providers to lose a lot of money, and there could be more pain on the horizon.

Outside of a few companies, it’s simply hard to see the upside in healthcare now. Volume has declined and the ETF is trading near its highs. However, the RSI is not as high as other sectors. While there will not be as much upside in this sector as others, there will also not be as much volatility. Therefore, I give this a HOLD call (and if you own a vaccine stock, consider trimming some profits).

Utilities (XLU)

Utilities fell over 1% on Thursday, however, this is a classic sector for defensive investors. It is a sector that does not move much upwards or downwards and is generally a safe place to park your money. However, investors have increasingly fled this sector towards riskier growth sectors to chase gains. Yet in the short-term and long-term, this sector may be a good hedge against volatility and bad news and may be a good way to invest in renewable energy and 5G.

According to the chart, this is possibly the best sector in the market to find value right now as well. Utilities are not exciting, and they will not give you robust returns, however, these are stable investments - if not boring. Utilities do not pose the same type of overheating risks as other sectors, such as small-caps and energy. Most importantly, no matter what the economic condition is and no matter what the news of the day is, you can always count on utilities to stay relatively tame. Therefore, at this valuation, I give utilities a BUY call - with the understanding that these stocks may not move much to the upside or downside but will provide a consistent yield.

Summary

While the surging spread of COVID-19 and resulting economic shutdowns may drive some short-term concerns, the progress made on the vaccine/treatment front poses significant optimism for 2021 and beyond. Pfizer had some somewhat disappointing news on Thursday; how jobless claims were quite encouraging. Sentiment seemingly changes day by day, but the long-term outlook for equities, namely value stocks and cyclicals, could be very positive.

We are thankfully in the home stretch of 2020. This has been a year filled with turmoil and pain, one that will hopefully end with happiness and optimism. But COVID-19 will not disappear before 2021 starts, and may be here with us a little bit longer. But if November showed us anything, it showed there is finally a light at the end of the tunnel. Until COVID-19 is brought under control or is eradicated though, there will be a continuous tug of war between vaccine optimism and health/economic pessimism.

Please keep in mind that markets are forward looking instruments and are investment vehicles that look 6-12 months down the road. However, it is very plausible that there could be some short-term uncertainty and volatility mixed in. But please remember how sharp and swift the rally was after the crashes in March. Since markets bottomed on March 23rd this is how the ETFs tracking the indices have performed: Russell 2000 (IWM) up 86.15%. Nasdaq (QQQ) up 79.08%. S&P 500 (SPY) up 65.86%. Dow Jones (DIA) up 63.02%. Markets long-term always end up going up and are focused on the future rather than the present.

If everything goes well with the vaccines, and the virus can be somewhat contained, the short-term volatility may be worth monitoring for opportunities before the eventual mid-term and long-term reality turns positive and stable in 2021.

To sum up all our calls, I have a BUY call for:

• Small-Caps (VSMAX) - but ONLY on a pullback for the long-term
• Utilities (XLU)

HOLD calls for:

• S&P 500 (SPY)
• Materials (XLB)
• Small-Caps (VSMAX) - in the short-term
• Health Care (XLV)

And I have SELL calls for:

• Financials (XLF)
• Energy (XLE)
• US Dollar ($USD)
• Communication Services (XLC)

Thank you.

Matthew Levy, CFA
Stock Trading Strategist