What makes May interesting is that there are several variables driving the market. We call this current environment a market rotation. It’s a rotation from growth stocks to value stocks. We saw this at the beginning of the year when we bought equal-weighted S&P, small caps, and structured buffered notes for clients as a hedge toward what may be a short-term rotation. Although we made these adjustments, we still have confidence in the conversation we started over a year ago: the world is changing more rapidly than ever, and the leap forward in technology and innovation from this pandemic has changed the game.
Before we start, lets define Growth versus Value Stocks
Value Stocks - Trading lower than their fundamental value, typical of a dividend stock or lower/slower growth stock.
Growth Stocks -Anticipated to perform significantly greater than average returns. Trades at anticipated value as opposed to Value which trades below their fundamental value
Growth stocks have been on a rise over the past decade. These tech companies have not only changed the way we live, do business, are entertained, communicate, healthcare, etc., but growth stocks outperform value stocks when interest rates are low. The concern over rising interest rates theoretically changes how people view the need to take on risk. If rates are higher, one is thought to have a more stable ability to make a return, thereby forgoing some of the need to take on growth risk. Value stocks have not seen a rebound since last March until now, and still have uncertainties like:
While at this point it is hard to ignore value’s rise and while we don’t necessarily think it will stop tomorrow, we see a few major flaws in the continued value push. The biggest flaw is in the financial strength these sectors have, as well as their ability to compete and grow. Especially when we see blowout earnings in growth stocks with continued strong forward guidance. The market hates all of these uncertainties, and it is better to see this reaction than to witness irrational exuberance with high appetites for risk. So, perhaps it is time for value to see a bit of stabilizing, or perhaps it will continue its upward trend, but the days of growth are not over. See our previous blog on how Covid presented us an opportunity to “leap forward”.
There is a lot to unpack, so let us take this one thought at a time.
The employment report on May 7th came in way below expectations, making people think the economy was not as strong as we all thought. But in fact, the real lesson from the employment report is, if you pay people not to work, then they won’t work - it is pretty simple.
3. Inflation: Should we be worried?
Federal Reserve: There is a lot of concern that the economy is running too hot, that it will spur too much inflation, and the Fed might be a wet blanket on the rally. We don’t think the Fed is going to do much of anything.
Short-term inflation is related to a number of items, and many of them may, in fact, be transitory (look at me, I sound like a Fed chairman).
Long-term inflation still appears to be low. One reason for this is the deflationary pressures from innovation, both reducing prices and making more current inventory obsolete.
4. The bond market, concerns over rising yields
Interest rates made a sharp increase earlier this year, and although it did not breach levels from before the pandemic started, it was a violent enough move to spook the market.
5. What does this mean for stocks? Growth was outperforming value at the beginning of the year, and that all changed when interest rates started to rise sharply in February. But there is more to it.
As tax reform was being discussed, one of the proposed increases was for the long-term capital gains tax to go from 20% to 39.6%. This is a big jump, and while it was only meant for households making more than $1 million, that news, in concert of rising rates, gave investors an excuse to ring the register and dump stocks that had risen the most. This included technology stocks and high growth stocks.
Some rotation was expected from the best-performing stocks, sectors, and subclasses as the rally broadened with a growing economy. Top-performing sectors year-to-date are energy companies and financials, especially large banks. Both of these industries are interesting candidates for such strong performance because they are also two of the most threatened industries from structural changes going on in technology and consumer trends.
6. Where do we go from here?
We still think it is the same story. There are structural changes happening in the world as a result of going mobile, remote, electrified, data-driven, and with the help of faster computing and artificial intelligence. Companies that are taking advantage of these trends will continue to succeed, and companies that don’t will likely go out of business. We are concerned about some of the companies in trouble, and we scratch our heads when we see people paying up for their stocks and chasing them.
Many of the best investments for the next five years go against the common thought. We like being unique in our ideas, and even if we are uniquely wrong, it is usually priced in. Being wrong is only really painful when you think you are safe, and then you get caught in the Black Friday rush for the door.
If you want to discuss these thoughts with us further and how to adjust your plan to maximize your return, schedule an appointment by: