The Equal-Weight S&P 500 Is at Risk of a Three-Day Correction
Bloomberg – As a proxy for the breadth of the recovery rally, nothing beat the equal-weight S&P 500, whose market-cap-agnostic structure let it benefit from giant gains in the most beaten-down stocks. But what worked going up is creating pain on the way down.
It’s taken just three days for a version of the S&P 500 that weights Southwest Airlines the same as Microsoft to get to the brink of a correction. Down 5.3% as of 1:30 p.m. in New York, the gauge has extended is losses from Monday to 10%. The decline is almost double the three-day retreat seen in the traditional S&P 500 that give more sway to bigger companies.
From cyclical stocks to small-caps, things that have buttressed the latest leg of market’s rebound are now leading the way down. As signs of a second wave of coronavirus inflections emerged, traders were quick to slam the sell button, reversing bets on a recovery trade that has helped broadened the market’s participation and send the S&P 500 to the best rally since 1933.
“Most people felt the market was ahead of the actual recovery, and the last leg up was likely driven by FOMO,” said Larry Weiss, head of equity trading at Instinet LLC in New York, referring to fear of missing out. Stocks other than tech giants “rose on hope, and the broader risk-on trade is reverting harder.”
Travel and leisure stocks, which have surged in recent weeks amid revival hopes, are tumbling, with an index tracking airlines plunging 12%. Financial and commodities firms, companies seen as benefiting most from a growth rebound, also bore the brunt of the selling among S&P 500 industries, each slumping about 6%. The Russell 2000 of small-caps dropped a similar amount, poised for a three-day, 10% decline.
While the selloff looks violent, it left the equal-weight S&P 500 at the lowest level in just two weeks, testatment to the powr of the rally. Still, the drop highlighted the market’s vulnerability to disappointing news about reopening.
“The problem is TX/AZ/CA cases moving higher at the same time that investors are expecting another wave to hit (because of the protest) in a week or so,” Dennis DeBusschere, head of portfolio strategy at Evercore ISI, wrote in a note, referring to states like Texas, Arizona and California. “If behavior changes as a result, the recent economic momentum will stall and fair value estimates move lower.”