INSIDE THIS EDITION:
Growth and Value Divergence to Continue?
Weekly Global Asset Class Performance
Mike Smith Interview with Dr. Vikram Mansharamani
Coronavirus / COVID-19 Resource Center
The equity market has returned to a familiar pattern where growth outperforms value. Although the markets have been choppy with some intraday volatility, we believe growth’s outperformance over value reflects the growing concern over the second wave of COVID-19 and the accompanying impact that could have on consumer behavior.
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The equity market has returned to a familiar pattern where growth outperforms value. Although the markets have been choppy with some intraday volatility, we believe growth’s outperformance over value reflects the growing concern over a second wave of COVID-19 and the accompanying impact that could have on consumer behavior.
If we look at the Russell 1000 Growth Index and compare it to the Russell 1000 Value Index, we see that growth has fully recovered its intra-year losses while value still has considerable ground to make up to merely get back to even.
In some ways growth’s strength relative to value mirrors what we saw 20 years ago (1999-2000) when growth shares pushed the markets to new highs before the dot-com bubble burst. In fact, the growth/value ratio is so similar today to what we saw during the dot-com era, that it has some investors wondering if this is a repeat of history.
As we look at the data in front of us, we think it is possible that divergent performance between growth and value continues on the back of two forces – the growing importance of technology and this week’s announcement that the Fed will impose caps on the dividend payouts of banks while also barring bank stock buybacks at least until September. We think this announcement has the potential to hurt the performance of large banks in the near-term and as a result make value underperform growth even more.
Why technology and financials factor so greatly in the relative performance of growth and value is that technology is strongly represented in growth indices while financials are a large component of the value indices.
To be clear, we have started in some ways to view technology as an indispensable consumer staple. With the reliance on technology intensifying as more people work from home, shop online, and use technology to maintain social connections during COVID-19, the tech sector is more defensive than it has ever been.
However, that does not mean it is immune to drawdowns. It is also not prevented from contributing to a broad market drawdown. In fact, if the technology sector falls, the broad markets are likely to follow. This is due to the high weighting to technology within the major indexes.
Further, we also have a handful of technology companies driving a big part of index returns. Take for example, the S&P 500. Since the start of 2018, the 5 largest stocks (Microsoft, Apple, Amazon, Facebook, and Alphabet) in the S&P 500 have outpaced the performance of the index. Combined strong performance in these technology names have resulted in substantially positive returns for the index over that time period.
Granted there are some technology names that have likely run-up too fast off the March 23rd bottom in our view. In fact, there are currently 18 listed companies in the United States with market capitalizations above $10B that have also returned more than 100% year-to-date.
Additionally, we have a median EV/Sales multiple for these firms of 20x. Yet, this valuation multiple is not necessarily a sign of froth for the broad domestic equity market. Especially not with interest rates at near zero, tremendous liquidity being provided by central bank stimulus, and the narrow leadership we see in major market indices.
But, nonetheless we currently believe there are risks investors need to keep an eye on. For one, the world economy is certainly experiencing a contraction. This week, the International Monetary Fund has adjusted growth projections for the world economy as they project both a deeper recession and slower recovery than expected just a couple of months ago. Currently they expect the global economy to contract -4.9% while the expectation is that US GDP will contract -8% compared to the prior estimate of -5.9%.
Naturally this downbeat forecast has caused bearish sentiment to persist at elevated levels. However, with the put/call ratio continuing to trend lower, it still looks like portfolio positioning is not yet reflecting investor bearishness and could be an indicator of investors commitment to chasing returns.
This is a bit concerning because we are also seeing many stocks still not trading above their 200-day moving averages, even in the tech-heavy NASDAQ. Again, this supports the notion that the rally, even in technology shares, remains fairly narrow.
Moreover, we have gross share buyback announcements falling to their lowest levels in over 15 years. This is before the move by the Fed to suspend stock buybacks from financial institutions in a move that will make the Gross buybacks dry up further.
Outside of financials, we think the reduction in stock buybacks shows management teams caution as they navigate through the COVID-19 environment. Second, a potential sign of concern over the disconnect that appears to exist between equity performance and economic fundamentals.
As we move ahead, holding cash in portfolios can serve as a buffer against potential volatility and corrections. This can also provide dry powder to deploy as opportunities to add equity exposure at attractive valuation levels arise.
Mike Smith interviewed Dr. Vikram Mansharamani
on The STA Money Hour.
Mike Smith interviewed Dr. Vikram Mansharamani on The STA Money Hour. The analysis of uncertainty. As we’ve become more reliant on data and technology, our focus has become more narrow and specific. Which is another way of saying “a broad and wider ignoring”. This concept about individual perception and perspective is what Vikram’s new book is about.
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