Dow Ekes Out 37-Point Gain on a Panicked Monday

Stocks ended mostly lower in Monday trading as a new strain of Covd-19 was identified. The S&P 500 tumbled early on, then clawed back to end with a moderate loss.

Stocks ended mostly down Monday as a new strain of Covid-19 has been identified. Stocks most correlated to the reversal of the economic scare seen Monday were getting hit hardest and could rebound fastest.

The Dow Jones Industrial Average rose 37.40, or 0.12%, to close at 30,216.45. The S&P 500 fell 14.49, or 0.39%, to end at 3,694.92, and the Nasdaq Composite slipped 13.12, or 0.10%, to close at 12,742.52.

The Dow rose partly because seven of the 30 stocks on the index rose substantially, while all else fell. First off, banks are now allowed by the Federal Reserve to buy back their stock and JPMorgan Chase (JPM) and Goldman Sachs Group (GS) stock rose 3.8% and 6%, respectively. Secondly, Microsoft (MSFT), a classic work-from-home cloud stock, rose 1.8%. Nike (NKE) crushed earnings estimates and shares jumped 4.9%.

The selling was severe across the board in early trading, with the S&P sliding to a low of 3,636.48, before clawing back to end the day with a moderate loss.

A new strain of Covid-19, found in the United Kingdom, spreads faster than the original strain and has spurred new travel restrictions in Europe.

Sure, Congress has agreed on a $900 billion fiscal stimulus package that includes unemployment checks, stimulus checks to households and small business relief. This provides ample cash to those parties of the economy so when vaccines are widely distributed, small businesses can rehire and consumers can spend. But if the new strain of the virus is resistant to vaccines, the world may be in for more hardship.

On the vaccines, The Wall Street Journal noted that scientists say the vaccine should work against the new strain. Equity strategists at Raymond James even pointed out in a note that “there is no evidence this mutation will impact the effectiveness of vaccines.”

That vaccines may work against the new strain and would enable fiscal stimulus to be fully relevant, partly explains why the stock losses moderated, Quincy Krosby, chief market strategist at Prudential Financial, told Barron’s.

Still, the morning panic’s chill didn’t fully wear off. Plus, many on Wall Street were saying last week that stocks were in an overbought condition after enjoying a rally since the end of September. Dec. 4 is the most recent date marking a pause in the rally, and the S&P 500 is down 0.1% since that day. Some on Wall Street—like Canaccord Genuity chief market strategist Tony Dwyer—are looking for a near-term pullback.

Some opportunities in the market may be cropping up.

Stocks most sensitive both to changes in the economy and reopenings were hit particularly hard. American Arlines Group (AAL) fell 2.5%. Carnival (CCL) fell 1.9%.

Beyond those stocks, the Vanguard S&P 500 Value Index Fund ETF (VOOV), home to many cyclical stocks, fell 0.5%. Oil stocks fell hard, with the Energy Select Sector SPDR Fund (XLE) down 1.9%.

Cyclical stocks have indeed been outperforming defensive stocks by a wide margin of late as confidence in reopening and a new economic expansion has be spurred by expectations of billions of doses of vaccines distributed in the next year. Cyclicals’ performance relative to defensive has hit a score of just under 90, according to strategists at Morgan Stanley. The higher the score, the wider the cyclical outperformance, The latest reading is up from a 2020 low of below 50 in March. But if the economic outlook continues to brighten and the fears ease, cyclicals can continue to win. The score hit almost 110 in early 2018.

Small-cap stocks, which are usually more sensitive to changes in the economy than large caps, fell hard initially, sending the Russell 2000 into the red early on, although it ended the day up 0.02%. Small caps have had an impressive run since the end of September as the economy has largely looked on track to continue. Near-term earnings growth is looking explosive for small caps, but their valuations are also still compelling.

Raymond James said the S&P 500 is at a valuation level that is in its 96th percentile, historically. That’s partly due to low interest rates making stocks more attractive, but Raymond James and others say this is overstretched. Meanwhile, small-cap forward-earnings multiples “are far more reasonable, which is one of the reasons we believe better risk/rewards continue to be found in smaller caps even after substantial outperformance in the past several months,” wrote Raymond James institutional equity strategist Tavis McCourt in a note.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com