09/08/2020
The passage of Labor Day typically begins a season of renewal. We feel a sense of anticipation and rising energy as the languid days of summer are replaced by the brisk days of fall. School is back in session, with all of the promise of a new year, full of learning and growth. And the workforce returns to a full complement, with renewed focus, as vacations come to an end. 

This year is anything but typical, however. The usual anticipation and energy of the season have been replaced by uncertainty and anxiety. There is widespread social unrest. The start of the school year is seemingly a patchwork of solutions, disjointed at best. For the 14 million unemployed there is no returning to a full workforce complement, and millions more of those with jobs are now working from home. The CDC reports that COVID-19 infections are now rising in 22 states. And the fast-approaching presidential election could hardly be a contest between two more diverse candidates. 

The Economy Fights to Gather Momentum 

It is against this backdrop that the economy has fought to gather momentum. But, supported by both fiscal and monetary policy, activity is improving. The August labor report is the latest evidence, as 1.4 million jobs were created, reducing the unemployment rate to 8.4 percent. That figure was enhanced by the addition of census workers, but the gains elsewhere were widespread across the service sector. Hospitality and leisure jobs evidenced a notable slowing, however, as the effects of the virus continued to plague the sector. The improvement in the labor market over the past four months may stall to some extent in the weeks ahead as the program support from the CARES Act expires. Washington has struggled to find common ground on the details of a fourth package, or whether another package is needed at all. And the gains in the August jobs report may lessen the urgency to get something done. 

The ISM PMI for manufacturing has also expanded for four straight months through August. New orders were exceptionally strong. The services component dipped in August compared to July, but remained at a very high level. Vehicle sales continue to firm as well. And anyone who has attempted to buy a house recently knows how tough the competition is, driven by a combination of low mortgage rates, low inventory, and virus-driven renewed interest in the suburbs. The Atlanta Fed’s GDPNow forecasting model currently anticipates growth of 29.6 percent in the third quarter, a dramatic turnaround from the 31.7 percent decline of the second. 

Stocks Fall After Delivering the Strongest August Returns in More than 30 Years 

The stock market has concurrently delivered exceptionally strong returns. After the strongest second quarter in 20 years, the S&P 500® index delivered a strong July, followed by the strongest August in more than 30 years. The improving economy brings with it the prospect of improving earnings, following second quarter earnings, which at -37 percent were nevertheless not as weak as expected. Factset reports that third quarter earnings estimates have actually been raised by 2.6 percent during the first two months of the quarter. This is in stark contrast to the average experience of the past five years which saw a 4.1 percent decline in estimates. Compared to last year, earnings in the quarter are still expected to fall by 22.4 percent, and revenues to decline by 4.1 percent. But relative performance is improving. Earnings comparisons year-over-year are expected to first turn positive in the first quarter of 2021.

But there has been a healthy dose of momentum buying in the third quarter as well. And until last Thursday, it resulted in the most popular growth names rising exponentially. The S&P 500 had climbed 16 percent in the quarter through last Wednesday, surpassed by the Nasdaq 100 with a gain of 22 percent. The most popular growth names were the leaders, including Apple, Amazon, Tesla and so on. But that momentum trade stumbled late last week. On Thursday and Friday, the S&P 500 was down 4 percent, and the Nasdaq 100 lost 6 percent. Apple fell 8 percent over the two-day period, Amazon fell 7 percent, while Tesla lost 6 percent. It turns out that excessive buying of call options, hedged by the seller through purchases of the underlying security in the cash market, had created a self-reinforcing feedback loop that pushed these individual stock prices ever higher. Until it stopped last Thursday. 

Whether there is more selling to come remains to be seen. At the very least, this episode is a reminder that while momentum investing can be rewarding, it is not without risk. It is a crowded strategy that last week hit a speed bump. The real pain arrives if that speed bump turns into a wall. Just as momentum buying helped drive the broader averages higher, given the dominant market cap this handful of growth names now represents, the unwinding of the trade has the ability to pull the broader averages lower. 
          
Important Disclosures:
Sources: Factset, Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.

U.S Department of Labor, Bureau of Labor Statistics News Release The Employment Situation – August 2020.

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Some of the opinions, conclusions and forward-looking statements are based on an analysis of information compiled from third-party sources.  This information has been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Ameriprise Financial. It is given for informational purposes only and is not a solicitation to buy or sell the securities mentioned. The information is not intended to be used as the sole basis for investment decisions, nor should it be construed as advice designed to meet the specific needs of an individual investor. 

The Purchasing Managers' Index (PMI) is an index of the prevailing direction of economic trends in the manufacturing and service sectors. It consists of a diffusion index that summarizes whether market conditions, as viewed by purchasing managers, are expanding, staying the same, or contracting. 

The GDPNow forecasting model provides a "nowcast" of the official GDP estimate prior to its release by estimating GDP growth using a methodology similar to the one used by the U.S. Bureau of Economic Analysis. GDPNow is not an official forecast of the Atlanta Fed. It is best viewed as a running estimate of real GDP growth based on available economic data for the current measured quarter. There are no subjective adjustments made to GDPNow—the estimate is based solely on the mathematical results of the model.

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