The S&P 500 ended a five-month streak of gains in August. Though investors have bid up many stocks in 2023 following last year's bear market, it appears the bulls may be losing steam.
Understanding the key forces that are shaping the market right now can help investors make informed decisions and avoid getting blindsided -- these two stocks illustrate some of the biggest underlying trends impacting the market today.
1. Block
Shares of Block (SQ 2.32%) fell 29% in August, and they've continued their slide so far this month. The bulk of those losses followed the company's second-quarter earnings announcement, even though the fintech leader delivered strong growth and exceeded Wall Street's expectations. The company's revenue expanded 27% year over year, and its adjusted EBITDA more than doubled.
Image source: Getty Images.
The report seemed like a success at first glance, but investors largely ignored those results as they focused on Block's uncertain outlook instead. Square, its payment solutions segment, is likely to experience some headwinds over the next few quarters thanks to slowing economic activity and consumer woes that are impacting retailers. Block's consumer finance segment, CashApp, is also likely to hit some stumbling blocks as demand for payments, transfers, and investment services declines. The company's forward-looking commentary wasn't overly pessimistic, but it wasn't enough to relieve investors' concerns about economic conditions.
The stock also struggled due to falling cryptocurrency prices throughout the month. Block owns a large amount of Bitcoin, and it generates revenue on trades of the cryptocurrency. While Bitcoin ultimately represents a small portion of the company's total assets and gross profit, there's still a strong connection between the stock and crypto in investors' minds.
So what does Block tell us about key market drivers right now? The company has settled into a unique spot as a modern bellwether stock. Its performance reflects macro trends in consumer spending, small business activity, capital markets, and more. Investor risk appetite is dwindling thanks to high interest rates and slowing economic activity. The trends that pushed Block lower can help explain a number of high-profile declines over the past month or so, including those for:
- PayPal
- Dollar Tree
- Dollar General
- Roblox
- Palantir
The SPDR S&P Retail ETF is down 9.2% since the beginning of August and the Vanguard Mid-Cap Growth ETF has tumbled 5.1%, so these issues clearly weren't limited to a small number of stocks. It's hard to forecast economic growth and the Federal Reserve's monetary policy in the short term, but the conditions driving these negative trends are unlikely to change drastically within the next one or two quarters.
2. Eli Lilly
On the opposite end of the spectrum, Eli Lilly (LLY 1.19%) was one of the most valuable stocks to record big gains in August with shares of the pharmaceutical stock charging 22% higher to a market cap above $550 billion. Investors celebrated Eli Lilly's second-quarter earnings report, which beat analysts' estimates and included an upward revision to its full-year forecasts.
The strong performance was attributed to several drugs in its portfolio, notably the diabetes treatment Mounjaro. This is the latest in a line of pharmaceuticals that have shown impressive efficacy in weight loss and diabetes management, which are rampant health problems in the United States and elsewhere. Investors are speculating that Mounjaro could gain approval for obesity therapy later this year, which would increase the addressable market considerably.
The pharmaceutical industry has been volatile since the start of the pandemic. Many of the big drug companies experienced temporary windfalls thanks to COVID-19 treatments, but falling demand for those products led to steep declines for several of the larger branded pharmaceutical stocks. With that disturbance mostly in the rear view, drug makers are getting more appealing to investors. Demand for medication tends to be fairly stable across economic cycles, and these stocks are generally less volatile than the market as a whole. Healthcare stocks tend to get more investor attention during slowdowns as a result. Healthcare was the second-best-performing sector in August, trailing the energy sector that was lifted by rising crude oil prices.
Eli Lilly was among the handful of companies with an undeniably strong performance and a bullish outlook, and that's exactly what it took to buck the overall downward trend last month. As investors fled other sectors, capital flowed toward those recession-resistant businesses with clear short-term growth catalysts. Gains aren't broad-based right now -- it requires unexpectedly good news to deliver these short-term returns.
The take-home message
Major indexes dropped in August, along with investor risk appetite, and they continue to do so in September. Many growth stocks were punished for reporting mediocre -- or even modestly favorable -- results as valuations shrank. This signals that more volatility lies ahead if economic conditions don't reverse course. However, there are still a number of stocks in pretty good shape.
It's important to avoid decisions motivated by fear or greed right now. Focus your portfolio on long-term performance, and make sure your volatility profile reflects your time horizon and risk tolerance. A sound investment strategy should balance short-term volatility and upside potential, and that balance is especially important in today's market.
