A Rough Week in a Hard Year – September 4, 2020

A Rough Week in a Hard Year – September 4, 2020
Morgan Lewis Posted on September 5, 2020

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

A Rough Week in a Hard Year

A week that started out manifesting the same sort of irrational market behavior as we have seen during COVID-19 suddenly turned chaotic. The new normal is anything but. The first part of the week we continued to see melt-ups in stocks that had announced splits despite the simple fact that four quarters still equal a dollar. Then Thursday, without warning, the broader market dropped precipitously and the tech stocks that have led this extraordinary rally led an abrupt and violent sell-off that extended into the early part of Friday. Although the market pared much of its losses by the end of Friday, it was clear that those who had been letting their gains ride, knowing full well that the environment was frothy, the rally was extended, and valuations were and still are rich, decided to take money off of the table and book some profits. This is to be expected. Trees simply do not grow to the sky, and even the healthiest of market environments must digest gains, particularly when valuations have become extreme. We are fond of saying that, often, momentum begets momentum. We saw that on the upside. Now, it’s possible this correction could have legs.

Precious metals and related stocks took time to digest their recent extraordinary gains. Gold was down 1.5 percent for the week. Related stocks fared slightly worse. The HUI Arca Gold Bugs Index was down 2.6 percent and the GDXJ Junior Gold Stock index was down 2.4 percent. Silver was down 2.2 percent for the week and platinum down 3.5 percent. In general, the selling seemed orderly in this sector, and technical support levels were not broken.

We continue to believe that there are structural tailwinds for this sector as the Fed is likely to be accommodative for the foreseeable future. It is willing to accept the risk of some inflationary pressure in order to avoid the possibility of catastrophic problems within the financial system. Many generalist funds are beginning to take note of the sector,including pension funds and the great Warren Buffett as we discussed on the weekly commentary last week:

Global natural resources were also hit across the board. The S&P Global Natural Resources Index was down 1.7 percent,also digesting gains off of the COVID lows. Energy was hit particularly hard. It struggles to catch any kind of rally, even in the best markets. WTI crude was off 3.7 percent; the S&P Oil and Gas Exploration & Production Index was off an incredible 6.6 percent.

The environment remains particularly tricky for crude. Although we have seen something of a demand recovery, air travel remains at low levels as airlines continue to eliminate flights and personnel. OPEC+ discipline in general remains adequate, but ultimately a demand recovery is necessary in order to see a sustained rise in prices. Natural gas also fared poorly, down 6.4 percent for the week after a sustained recovery off of the lows.We are slightly more constructive on natural gas, as we believe that declines in Permian activity have reduced the supply of produced associated gas. That said, inventories remain high, and are still 13 percent above the fiveyear average.

Real estate had a relatively quiet week. The Dow Jones Equity REIT Total Return Index was down 73 basis points. The most badly beaten subsectors led the sector – namely hotels, shopping centers, and malls, up 1.8 percent, 4.5 percent, and 34 basis points, respectively. We are optimistic that a deepening market and economic correction may afford us select and idiosyncratic opportunities in this sector, although we remain cautious on real estate more broadly.

Infrastructure was something of a port in the market storm. The US Infrastructure ETF was down a percent. However, as is usually the case, performance was bifurcated. On one hand, the Alerian MLP index, which is comprised largely of energy infrastructure, was off 4.7 percent. On the other hand, the Dow Jones Utility Average was up 37 basis points. Although utilities are expensive, it has become something of a relative market value. At 21X forward earnings, a steady and visible stream of cash flows and a 3.3 percent yield are far more interesting to us than an EV manufacturer trading over 1100X. So, on a relative basis, we are constructive on this defensive area of the market.Compounding returns on capital may be a boring proposition to your average Robinhood day trader, but playing stocks for splits at the casino is just excitement we can do without.

Best Regards,

David McAlvany
Chief Executive Officer

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