Telemus Special Market Commentary: Changing Seasons

The equity market had a strong month of August, driven by gains in large cap technology stocks such as Facebook, Amazon, Apple, Google and Microsoft (the FAAMG group). It turns out the gains derived during the best August since 1984 were at least partially fueled by large purchases of option contracts in these large cap technology companies. SoftBank has been reported to be the ‘Nasdaq Whale’, or a large investor that had purchased a sizable number of those contracts.

As September rolled in, a combination of concerns around the run up in technology shares, jitters around the upcoming election, and a lack of progress by congress on additional fiscal relief ignited an initial selloff. Option traders who had to buy shares in the big tech stocks to hedge the option contracts on the way up in August, began to unwind their positions as the market fell. This created a bit of a domino effect, likely leading other investors that were concerned about technology stock valuations to follow suite.

It’s natural to expect a pullback after significant upswings, particularly those punctuated by a spike in volume. Even though the S&P 500 has pulled back 7% from its recent record high, it remains at levels where it traded a mere month ago. There have been statements made in the press on whether we are in another tech bubble, reminiscent of the late 1990’s. We view this analogy to be misleading on two fronts. First, the FAAMG stocks that have been driving the market higher are established businesses, with sizable moats, high levels of profitability and pristine balance sheets. While we might argue the prices of these stocks may be a little ahead of themselves, they aren’t embedding aspirational expectations. Second, the notion of a bubble implies that stock prices more broadly are susceptible to popping. The rally in the market, and the upswing in August in particular, has been quite narrow. Aside from large technology companies, valuations in many other parts of the market appear more reasonable. Therefore, we see opportunities in the broad market, just in different stocks than what has driven the rally thus far. As such, the market may be nearing an inflection into an environment where the performance of individual stocks may become more influential to portfolio returns than changes in the broader market.

With Labor Day behind us, rhetoric associated with the election will accelerate. We would expect volatility to pick up as investors react to changes in potential electoral outcomes. A more balanced blend of upswings and downswings is likely ahead, with the opportunity for stock selection to come to the forefront.