The stock market shakeout is likely not over yet, even with Friday's comeback

A pedestrian outside the New York Stock Exchange in New York, July 29, 2020.

Wang Ying | Xinhua News Agency | Getty Images

The tech wreck is probably not over, despite Friday’s market comeback.

Analysts expect the shakeout in stocks to continue after the long Labor Day weekend, especially in technology names and the Nasdaq, areas of the market that notched the sharpest gains.

After August’s 7% gain in the S&P 500, stocks started September strong, and then just as quickly rolled over. The Nasdaq lost 5% Thursday and was down sharply Friday before rebounding. The S&P 500 was down about 1.5% for the week, even after a 3.5% loss Thursday.

“I think this is a good wake-up call and a reminder that there are risks out there,” said Leo Grohowski, chief investment officer at BNY Mellon Wealth Management. “In August, we did take a little bit off the table.”

Analysts expect the week ahead to be busy, with holidays ending and more market pros back at their desks. There is some economic data, most importantly Friday’s consumer price index. The reading on consumer inflation is expected to show little change in core inflation with forecasts for a gain of just 0.2% in August, or 1.6% year over year.

Froth blowing off

The stock sell-off came as market pros were becoming increasingly wary of froth in the market, particularly in tech and momentum names. On Friday, it was revealed that SoftBank was behind billions in large options bets on individual tech stocks, like Amazon, Microsoft, Apple and Tesla. New reports said the trades were made over the past month, building unusually large positions in call options, or those that bet the prices of underlying stocks would rise.

One analyst said the fact that SoftBank was “gunning the market” makes him worry that there is more selling to come in Nasdaq names. As SoftBank bought call options, the sellers had to buy stocks, conceivably driving up prices in a trading feedback loop.

“It’s just a trip to the casino,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “If they’re supposed to be an investment company taking a long-term horizon, then trying to juice your short-term return through options, you’ve turned into a hedge fund.”

JPMorgan strategists said they expect the market to recover gradually, but there are still presidential election uncertainties looming in the next couple of months.

“The significant reduction in previously extreme long positions in Nasdaq by momentum traders should allow the equity market to recover over the coming weeks, as happened after the June 11th correction,” noted JPMorgan analysts. “But a repeat of the strong gains seen during July and August is less likely over the next two months.”

Grohowski said there could be more selling in the tech and internet companies, or those that were viewed did well as workers stayed home and the economy was shutdown. “It’s not the start of a big lasting correction, but a forewarning the next couple of weeks and months are going to be choppy. I think it’s going to be a sideways kind of market,” Grohowski said. He added the market could be choppy in the week ahead.

“We’re a little more cautious, not to mention the market is trading at 23 times our earnings estimates for 2021,” said Grohowski. He said the fact there is about $4.5 trillion in money market funds is a bullish signm since that money could find its way into the stock market.

Julian Emanuel, head of equities and derivatives strategy at BTIG, said the S&P 500 could dip to its 200-day moving average, or 3,092, before rebounding, which would be about a 15% move in total.

“I don’t think the sell-off is over. Nasdaq is up 83%s since March 23, the S&P is up 63%,” said Emanuel.