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Why growth stocks could rally from here

·Contributor
·4 min read
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Over the past seven weeks, we have seen two different markets. Growth stocks have been in a correction (as seen in the Nasdaq Composite) while other sectors such as value and the “opening up the economy” stocks have been in a strong uptrend (as seen in the S&P 500 and Dow Jones). 

From here, we will start to see growth pick up again and participate to the upside for the following reasons.

Sentiment 

The correction in growth stocks had less to do with interest rates and more to do with the excess bullish sentiment that was created earlier this year. This led to a large supply of equities that came to market via secondary offerings and SPACs, as many companies like to take advantage when prices are high. The price action of the past seven weeks helped to deflate that bullishness, as many winners from last year corrected 30%-50%. In addition, there has been a slight increase in put buying over the past two weeks, and last week saw the largest tech outflows since September 2020. 

Source: Bank of America Global Research
Source: Bank of America Global Research

Seasonality 

Over the next four to six weeks, the news cycle will shift from interest rates and geopolitical nonsense to focusing on fundamentals and the upcoming earnings season. According to Ryan Detrick at LPL Financial, “stocks have closed higher in April an incredible 14 of the past 15 years.” He goes on to say that since 1950, April has been the second-best month for stocks, and the best month over the past 20 years. Also, any money normally taken out to pay capital gains taxes will be delayed until mid-May with the recent IRS tax filing extension.

Technicals

Last week saw two positive developments in the Nasdaq Composite. On Wednesday, March 31, the index triggered a follow through day (FTD). A FTD is a big up day that occurs on higher volume than the previous day. It does not guarantee that a market has bottomed, but no market bottom has occurred without one. Rather than getting too technical, think of it as a bullish sign that big institutions are coming back into the market. The second positive development is that the index got back above its 50-day moving average on Thursday, April 1

Chart is provided by Market Smith.
Chart is provided by Market Smith.

The Fed 

We continue to be in a very favorable environment for equities. As I have written many times, there is a coordinated effort from all the major central banks to keep interest rates low and the markets high. Fed Chair Powell is committed to his near-zero interest rate policy until the economy shows strong signs of recovery from the pandemic. As they say, “Don’t Fight the Fed!” Well good luck fighting all the global central banks. Don’t argue with it; take advantage of it while it lasts.

Semiconductors 

The strongest area of growth right now is the semiconductor sector. The main ETF (SMH) already started to resume its uptrend a week before the Nasdaq Composite, and this could be a leading indicator for technology overall. The sector is benefitting from the chip shortage as semiconductors are not just going into computers and smartphones, but also into cars, appliances, medical equipment, and much more. The group within the sector that will benefit the most are the chip equipment makers. Many of these large cap leaders closed at all-time highs last week. Examples include Applied Materials (AMAT), KLA Corp. (KLAC), ASML (ASML), and Lam Research Corp. (LRCX).

Over the next four to six weeks, we could see a rally in stocks that takes the Nasdaq Composite back to new highs and the S&P 500 to 4200. The rally will see technology stocks participate ahead of their Q1 earnings reports, and under-invested fund managers might be forced to put money back to work if the S&P 500 starts to see double-digit gains on the year. In addition, the favorable low interest rate environment provided by the Fed will continue to act as a strong backdrop for equities.

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I can be reached at: jfahmy@zorcapital.com

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