Stocks gained on Tuesday (Jan. 5) after the major indices all sold off to start the year on Monday (Jan. 4).

News Recap

• The Dow Jones closed 167.71 points higher, or 0.6%, at 30,391.60. The S&P 500 advanced 0.7% and the Nasdaq climbed nearly 1%
• The Georgia Senate run-off elections on Tuesday (Jan. 5) were the main focus of investors. At the time of publication, Democrat candidate Raphael Warnock was declared the winner over the incumbent Republican Kelly Loeffler for the first Senate seat up for grabs. The other contested seat between Democrat Jon Ossoff and incumbent Republican David Perdue had yet to be called.
• The balance of power in the Senate depends on these results and markets could be volatile. Many believe that if the Democrats sweep the Georgia seats and win control, then higher taxes and progressive policies could hurt the market. On the other hand, others believe that a Democrat sweep could bring on larger and quicker stimulus relief.
• Better-than-expected ISM U.S. manufacturing data came in and helped stocks higher. According to the ISM, manufacturing rose to 60.7 in December from 57.5 in November. The consensus was that the index would slightly decline to 57.
• Energy stocks led the S&P higher and soared by 4.5% after Saudi Arabia agreed to voluntary production cuts in February and March. Oil giants such as Chevron (CVX) rose 2.7% as a result.
• Oil futures surged by 4.9% and briefly broke past $50 a barrel for the first time since February.
• Copper is a precious metal traditionally seen as a leading indicator for the global economy. On Tuesday (Jan. 5), it hit its highest level in nearly eight years and gained more than 2%.
• Gold also reached an 8-week high due to more declines from the dollar.
• Boeing (BA) was the best-performing Dow stock and gained 4.4%.
• U.K. Prime Minister Boris Johnson on Monday (Jan. 4) announced a national lockdown to slow the spread of a new, more contagious, coronavirus strain. Under these restrictions, people are only allowed to leave their homes for essentials, work (if they can’t from home) and exercise. Most schools, including universities, will also move to remote learning.
• According to data compiled by Johns Hopkins University, more than 85 million COVID-19 cases have been confirmed globally, including 20.8 million in the U.S. and 2.7 million in the U.K.
• Meanwhile, over 5 million people in the U.S. have now received a COVID-19 vaccination.

After stocks sharply dropped on Monday (Jan. 4) to kick off 2021, widespread gains on Tuesday (Jan. 5) offset some of these losses. While Monday (Jan. 4) was the first time since 2016 that the Dow Jones started a year off with declines, two major catalysts sent the major averages higher: the oil production agreement reached between OPEC and Russia, and better than expected manufacturing results from December.

This tug of war between good news and bad news can be expected in the early part of this new year. Although Monday (Jan. 4) witnessed a sharp pullback (and in my opinion, a predictable one), Tuesday (Jan. 5) witnessed a reversal. In general, though, I still believe that markets have overheated and that between now and the end of Q1 2020, a correction could likely happen.

Markets have overheated, and I believe that much of the good news ranging from economic stimulus to vaccines has been baked in. Eventually, the reality on the ground will outweigh the positive news in the short-term.

National Securities’ chief market strategist Art Hogan put it best in my opinion, saying that he believes we could see a 5%-8% pullback as early as this month. Hogan said that “we have a tug of war between virus news and vaccine news the better part of six months, and that’s been balanced off by stimulus...That seems to be behind us, and right now I think the virus news takes over a little bit.”

Additionally, if the Georgia elections on Tuesday (Jan. 5) go as I think they’ll go (Democrat sweep), it could be a short-term catalyst leading to a potential correction. The balance of power in the U.S. Senate is at stake with these elections. Investors are likely to prefer a divided Senate. If the Democrats sweep and wrestle away Senate control from the Republicans, it could leave President Biden’s powers largely unchecked, and enable him to pass more ambitious, progressive, and less market-friendly policies.

At the time of this publication, Democrat candidate Raphael Warnock was declared the winner over the incumbent Republican Kelly Loeffler for the first Senate seat up for grabs. The other contested seat between Democrat Jon Ossoff and incumbent Republican David Perdue had yet to be called.

According to John Stoltzfus, chief investment strategist at Oppenheimer Asset Management , the S&P 500 could fall by 10% if the Democratic candidates sweep the Georgia runoffs.

“It is thought by not just a few folks on Main Street as well as on Wall Street that if tomorrow’s run-off results in a sweep for the Democrats — providing them with control of the Senate as well as the House — that it would bode ill for business with the likelihood that corporate tax rates could rise substantially,” Stoltzfus said.

On the other hand, a Democrat sweep could mean potentially larger stimulus packages - and soon.

There is optimistic potential, but the road towards normality will hit inevitable speed bumps and uncertainty. This Senate election and the potential market reactions reflect that.

If and when a correction does happen, I believe it will be healthy and a good thing. Corrections are normal market behaviors and happen more frequently than most realize. Only twice in the last 38 years have we had years WITHOUT a correction (1995 and 2017). Since we have not had one since March 2020, I believe we are long overdue, and the catalysts are there. Most importantly though, a correction could be a great buying opportunity for what I believe will be a strong second half of the year.

While there will certainly be short-term bumps in the road, I love the outlook in the mid-term and long-term once vaccines become more widely available. The pandemic is awful right now, and these new infectious strains are quite concerning. But despite this, I believe the positive manufacturing data released on Tuesday (Jan. 5) is a step in the right direction, especially considering all the restrictions that most countries are living through.

The consensus is that 2021 could be a strong year for stocks. According to a CNBC survey which polled more than 100 chief investment officers and portfolio managers, two-thirds of respondents said the Dow Jones will most likely finish 2021 at 35,000, while five percent also said that the index could climb to 40,000.

Therefore, to sum it up:

While there is long-term optimism, there are short-term concerns. A short-term correction between now and Q1 2021 is very possible. But I do not believe, with conviction, that a correction above ~20% leading to a bear market 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, please do me a favor and let me know what you think of this segment! I’m always happy to hear from you.

Driving

Materials (XLB)

Figure 1 - Materials Select Sector SPDR Fund (XLB)

The materials sector, as represented by the XLB ETF, touched a 52-week high and was one of the best performing sectors on Tuesday (Jan. 5). The XLB surged by 2.25%, largely buoyed by several macro-level tailwinds.

Materials companies could be some of the biggest beneficiaries of vaccines getting us back to normal. With this new stimulus package and a weakened U.S. dollar, the bullish drums are certainly beating. Historically, dovish economic policies and a weak U.S. dollar have benefitted materials.

Because materials largely benefit from a weak dollar, emerging markets and materials are also historically correlated. As I am very bullish on emerging markets for 2021, I believe that materials could follow suit.

On one hand, I believe that this sector could pull back further in the early parts of 2021 along with the broader market. On the other hand, the Democrats appear primed to take control of the Senate. I believe that this means more stimulus, an even weaker dollar, and more room for materials to run. I previously said that I do not foresee a consistent rally happening until the end of Q1 2020. But I do foresee the XLB ETF eventually exceeding its 52-week high and going on a nice rally. I would just like to see a pullback first since the XLB is at its high. Besides that, I love materials.

For the time being, this is a short-term HOLD but a BUY on a pullback.

Energy (XLE)

Figure 2 - Energy Select Sector SPDR Fund (XLE)

Avoiding energy has been one of my biggest conviction calls for weeks. Energy is a sector largely dependent on sentiment. Although energy stocks surged on Tuesday (Jan. 5) due to the OPEC production deal, I do not believe this surge will last. Because the Democrats will likely win both Georgia Senate seats, I also believe Tuesday’s (Jan. 5) gains could potentially go away by the end of the week. This is simply par for the course in the energy sector. Throughout 2020, the sector has had big rallies that have eventually fizzled. I believe this pattern will continue in 2021.

There are just so many question marks for energy in the short, medium, and long-term.

On one hand, if you are bullish, the vaccine bodes well for a full economic reopening by the second half of 2021. That means travel, and therefore fuel demand, could surge back to pre-pandemic levels. By any measurement, energy is still largely undervalued as well.

But I believe that all of these tailwinds have already been baked in. Stricter shutdowns and travel restrictions are being imposed with fresh concerns over global fuel demand. In fact, according to Ned Davis Research, U.S. crude demand is still over 1.0 million barrels a day below pre-virus levels. I believe this will continue throughout Q1 2021.

In the long-term, 2021 could also witness further movements away from fossil fuels towards clean and sustainable energy. Pension funds worldwide have been divesting from oil in droves, for example.

With the Democrats poised to have an even bigger say in the government, and therefore with oil and energy, I have a hard time thinking bullish thoughts on this sector.

While there is vaccine optimism now that there wasn’t before, conditions are largely the same on the ground concerning COVID-19 and travel demand. Therefore, my call is to take profits and SELL.

Financials (XLF)

Figure 3 - Financial Select Sector SPDR Fund (XLF)

The financial sector is near its 52-week high, but I have some serious concerns. I do not believe this sector will benefit from a dovish Fed in the long-run, or a Democrat controlled House and Senate looking to take on big banks and Wall Street.

Interest rates - a huge driver of banking revenue - will not rise until 2023 at the earliest. While financial stocks have performed better than the U.S. dollar, rates this low for so long will not be good. Until rates start rising again, profit margins will continue to narrow.

Although higher-quality loan applications and an influx of new investors have helped certain banking stocks, I don’t believe it will be enough for mid-term and long-term strength.

I foresee a rise in COVID-related defaults coming in 2021 as well. With potential defaults on the horizon, and without raising interest rates, it’s hard to truly justify the gains.

The theme of mixed sentiment continues for this sector. Because so much of the sector’s revenue depends on interest rates, and those will not go anywhere for the foreseeable future, I have this at a SELL. Take the profits while you can!

Diving

Communication Services (XLC)

Figure 4 - Communication Services Select Sector SPDR Fund (XLC)

The XLC Communication Services ETF gained yet underperformed other sector-focused ETFs on Tuesday (Jan. 5). This is not surprising at all, and an illustration of why communications stocks do not excite me at all. Even when markets outperform, communications stocks seem to underperform.

While traditionally this is a good sector to find value in, right now I just don’t see it. The ETF is trading near its 52-week high, and I see downside risk without the same type of upside potential as other sectors that could benefit more from a successful vaccine roll-out and economic reopening - like small-caps and materials.

The ETF’s volume is already low and has been unstable too. This screams volatility to me.

I just can’t see how you would benefit from buying into this sector. It is hard to foresee how this sector will truly benefit from a vaccine and a 2021 reopening relative to other sectors. Therefore, I give it a SELL call.

Health Care (XLV)

Figure 5 - Healthcare Select Sector SPDR Fund (XLV)

Healthcare has been one of the best performing sectors since mid-December. Although the Healthcare Select Sector SPDR Fund (XLV) is near its 52-week high, I do not believe that the healthcare sector will necessarily benefit from vaccines in the short-term.

Good vaccine news could cause short-term surges in companies that are directly involved in vaccine production and distribution such as Pfizer (PFE) and Moderna (MRNA). But in my view, vaccine-induced returns for these companies were already baked in.

Vaccines will not be a long-term profit driver for these companies. Just take Pfizer’s and Moderna’s stocks for example. These are vaccine stocks that surged on news that their vaccines worked. Despite both Pfizer and Moderna rolling out their vaccines last month, since peaking December 10th, Pfizer’s stock is down 10.88% while Moderna’s is down 29.87%.

Meanwhile, the pandemic has caused hospitals and providers to lose a lot of money, and there could be more pain on the horizon. Hospitals generate a lot of their revenue from elective procedures. With the pandemic, hospitals’ resources are being stretched thin, and they are often prohibiting these types of procedures. ICU capacity across the US is seemingly declining by the second as well.

Outside of some blue-chip companies to invest in for the long-term, it’s hard to see the upside in healthcare right now. According to Ned Davis Research, only 84.4% of issues are trading above their 50-day moving averages- the fourth-lowest among all sectors.

The XLV ETF has shown fewer signs of volatility than other sector-specific ETFs and can outperform on any given day. But I would prefer it pullback before initiating a position. Therefore, I give this ETF a HOLD call.

Utilities (XLU)

Figure 6 - Utilities Select Sector SPDR Fund (XLU)

A lot of investors avoid utilities or don’t like them. I get it. Utilities are not exciting to invest in if you’re focused on returns and growth. Especially during bull runs.

After outperforming in September and October when the market saw a brief downturn, this sector has been a laggard since November. Utilities though are dependable stocks and may offer the best opportunity to find value in a market this overinflated, manic, and unpredictable.

Utilities are considered to be defensive investments, and as a result, have underperformed. However, on days where there is volatility and investors are either taking profits or running for the hills, it’s a good sector to own.

This is a boring sector not focused on growth or gains. But during uncertain times, this is a safe place to find value. Utilities are cheap, they do not swing much upwards or downwards, and pay solid dividends.

In the short-term and long-term, this sector may also be a good hedge against volatility and bad news and may also be a good way to gain exposure to renewable energy and 5G. Renewable energy especially could thrive under a Biden administration and Democrat controlled House and Senate.

Utilities do not pose the same type of overheating risks as other sectors such as small-caps. 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. The RSI is lower than other sectors and the ETF is trading below its 50-day moving average.

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 current headwinds are very concerning, I am optimistic for the second half of 2021. The path there could be bumpy though.

Until COVID-19 is eradicated, there will inevitably be a tug of war between optimism and pessimism. Additionally, there are some short-term question marks with these Georgia results.

I believe that a short-term correction to start 2021 is inevitable. But do not let this scare you. Remember- corrections are NORMAL and markets are forward-looking instruments that look 6-12 months down the road. Although it is very plausible that there could be some short-term uncertainty and volatility, use this as a time to find buying opportunities for the second half of 2021. Do not get caught up in fear if there is a correction.

I do not believe a crash like the one we saw in March is on the horizon, but a pullback of some sort is coming. Do not be fearful though. Since markets bottomed on March 23rd, here are how the ETFs tracking the indices have performed: Russell 2000 (IWM) up 99.49%. Nasdaq (QQQ) up 83.87%. S&P 500 (SPY) up 68.67%. Dow Jones (DIA) up 65.39%.

In the long-term, markets always end up moving higher and are focused on the future rather than the present.

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

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

HOLD calls for:

• Materials (XLB)
• Health Care (XLV)

And I have SELL calls for:

• Small-Caps (IWM) - in the short-term. But do not fully exit positions.
• Financials (XLF)
• Energy (XLE)
• US Dollar ($USD)
• Communication Services (XLC)

Thank you.

Matthew Levy, CFA
Stock Trading Strategist