- Value, cyclical and reopening stocks are all the rage as vaccines roll out and we prepare for some return to normal life.
- Apple, Amazon and other large cap growth names carried the market last year, but have been underperforming for months.
- While the near term favors cyclicals, don't overlook the long-term growth rate of the tech sector.
Although Roaring Kitty and Gronk — two names that make me smile every time I say or write them — may create enough frenzied bidding among crowds of novices, speculators and spectators, there are other compelling issues for investors to focus on besides GameStop, AMC and non-fungible tokens or NFTs.
These include tensions playing out between two competing cohorts of investors.
On the winning side, since last September, are adherents of value, cyclical, and reopening stocks that have been rallying hard.
On the losing side are investors who have owned the large cap growth stocks, such as Apple, Amazon, Facebook, and Netflix, that carried the market through most of 2020. These digital giants have been underperforming cruise lines, hotels, banks, industrials, and energy stocks for months.
Both sides agree on one thing: Gross domestic product growth will be combustible in 2021, thanks to two critical factors. The first is widespread vaccination, and the second is the enormous $1.9 trillion stimulus package that President Joe Biden just signed.
These allow for the resumption of huge swatches of the economy and the money to pay for those activities, products, and services. Estimates range from 5% to 7% economic growth this year, the type of numbers that make economists salivate. Party on!
There is no doubt that the earnings growth for those sectors whose businesses were decimated by the pandemic will be stronger in the coming year than for those companies that profited from remote life and work.
Going from down 85% in airline flights for much of 2020, to down 50% from the pre-pandemic year, is still up 233% year over year.
However, that doesn't mean that when Americans spend their next $1,400 stimulus check, they won't be buying iPhones and using PayPal to make that purchase, or that companies won't be advertising more to those consumers on Google or Facebook.
The long-term growth rate for the technology sector is clearly higher than that of oil service, heavy construction equipment, or airlines, but the near term favors these cyclicals.
The important question for investors is always which stocks are most attractive. The cyclicals, all dramatic underperformers in 2020, began their awakening in September, with momentum building after the election and release of positive vaccine data.
As the table below illustrates, Tech and Communications Services have lagged Energy, Financials and Industrials, the three major "value" groups.
Surprisingly, as the last column suggests, the earnings multiples for most S&P sectors, excluding Financials, are very similar.
That holds true for digital growth stalwarts — including Microsoft, Facebook and Google — that sell at about the same ratio of price-to-forward-earnings as Caterpillar, Deere and Emerson Electric, despite having stronger long-term growth expectations.
When asked about the direction of equities in 2021, most value investors concur that they see both GDP and the S&P rising but driven by their preferred stocks.
That assertion could be so mathematically challenging that a more sensible strategy might be to include both groups of stocks in a portfolio rather than dismissing growth as last year's news.
The market cap weights of Technology, Communications Services, and Amazon alone account for 42% of the entire S&P 500.
If these stocks, in aggregate are flat for the year, as well as Health Care, Consumer Staples, and Utilities, with the S&P advancing 10% for the year (it's already up 5%), the reopening and cyclicals would need to climb another 27% from their current level, a difficult feat considering their six-month rally.
The table below highlights the performance of the S&P and the tech-heavy Nasdaq during years of strongest GDP growth and those following a recession since 1975.
In every case, except 2000, the year in which the dot-com bubble burst, the S&P 500 experienced positive returns.
Across all years, the Nasdaq Composite both outperformed and underperformed the S&P five times and was in line with the broader index once. By far, the worst year was 2000, when the composite dropped 39%. The best year was 1999, when it soared 85.6%.
The case has been made that 2021 is comparable to 2000, but the similarities relate primarily to the extreme euphoria surrounding the most expensive stocks.
These Robin Hood market darlings, many in software and biotech, sell for 10 to 50 times revenues. They traded straight up from early in the pandemic.
These names include CRISPR, Tesla, Peloton, Snowflake, and Palantir, plus newer IPOs, such as Airbnb and DoorDash. Many have already hit air pockets, some very steep, but could still have room to decline before finding solid ground.
That doesn't mean that the more reasonably priced stocks within the Technology and Communications Services sectors, including the largest weights in the S&P 500, cannot begin to show some renewed vigor.
I don't think we need to query Roaring Kitty or Gronk on the subject, but since everyone is asking them to weigh in on investments, sure, why not?
Karen Firestone is chairman, CEO, and co-founder of Aureus Asset Management, an investment firm dedicated to providing contemporary asset management to families, individuals and institutions.