This week marked the one-year anniversary of the Coronavirus Crash market bottom. After the massive one-year gains for equity markets since the March 23, 2020 low, it is hard to get too upset over a couple of weeks of sideways or negative trading action, but that is where we find ourselves. We continue to pay attention to the style and sector rotations. The “innovation” and new stocks of 2020 are falling back, but there will be others stepping up to take their shot.
Even though my NCAA tournament bracket is busted, I’m still going to make a basketball and stock market metaphor. A “heat check” is mostly a basketball term. It’s used whenever a player starts to find a scoring rhythm and then decides to test the limit. Maybe they’ve made a couple of layups, then a mid-range jumper, and then a couple of three-pointers. In the old NBA Jam video game, the basketball would literally be on fire in their hands at this point. So, they decide to pull up 35 feet from the basket with somebody in their face. That’s the heat check to determine if they are actually hot or not.
Coming into 2021, growth-style technology and consumer discretionary stocks were absolutely hot. These companies benefited from the stay-at-home coronavirus pandemic economy and subsequent asset flows into the trade. ARK funds and their CEO/portfolio manager, Cathie Wood, attracted more than $20 billion of inflows into actively managed growth strategies last year! And, these growth-style equities outperformed their value-style counterparts by historical levels that drew comparisons to the technology bubble of the late ‘90s.
There was some rotation towards value-style industrials, financials, and energy companies at the end of 2020. It was fairly subtle, starting in September when the stock market had a near correction and value lost less than growth, and then again in October. Finally, in November, the rally kicked in, and value actually outperformed on the upside.
Even as the styles performed some mean reversion at year-end, the high-flying tech stocks held their ground pretty well. For the past few years, investors have been happy to pay any price for growth stocks and this was no exception. Now, for reasons that are up for debate, they may be changing their minds. Generally, investors don’t go from euphoria to despair overnight; it’s more a gradual transition. However, something clicked in mid-February, and people started to head for the exits. As you will note below, the hottest stocks during the coronavirus pandemic stock market recovery including Tesla, Peloton, Zoom, and Snowflake are down anywhere from 30% to 50% from their 52-week high.
The catalyst is a bit unclear, although rapidly rising interest rates have taken the brunt of the blame. The 10-year US Treasury yield has climbed from 1.13% on February 9th to 1.66% as of Friday’s close. Higher interest rates translate to higher borrowing costs, which disproportionately affects inorganic, debt-aided expansion and companies that lack earnings and free cash flows.
Whatever the reason, the previously hot players airballed their shots over the last month and a half, but thankfully, there were other players heating up.
It is logical to divide this coronavirus pandemic market recovery period into a couple of phases. The first phase starts at the bottom of the downturn on March 23, 2020 and ends when the market reached a new all-time high on September 2, 2020. Although every sector participated in the recovery, this stretch was dominated by the technology and consumer discretionary sectors. Those sectors returned +80% and +76%, respectively, versus +61% for the S&P 500.
The other leading theme was large caps outperforming small caps. The largest five companies – Apple, Microsoft, Amazon, Google, and Facebook – were uniquely qualified and positioned to capitalize on a situation where everyone needed to work and shop from their homes. The top 5 outperformed the other 495 stocks in the S&P 500 index during both the drawdown period and during the first phase recovery period by 62% on average.
In the second phase of the recovery period starting on September 3, 2020, and through Friday’s close, we have experienced some reversion to the mean on a sector basis. Energy and financials, which experienced painful drawdowns and lagged during the phase one recovery, are the leading sector performers. This makes perfect sense as oil is back over $60 per barrel and interest rates are on the rise (and loan losses came in better than expected).
The combination of the energy and financial sectors account for only 2-4% of the S&P 500 and Russell Growth indexes, but they are 26% of the large cap S&P Value and Russell 1000 Value Indexes and an even higher 32% of the small cap Russell 2000 Value Index (nearly 27% financials). That sector composition in the style indexes helps explain the narrative of value’s (specifically small cap) recent outperformance.
As you may note, all sectors are positive during this second phase of the recovery. Sector breadth shows that most of the stock market remains impressively strong even though areas like SPACs and “innovation” stocks have shown recent weakness. Six of the eleven sectors have more than 90% of their stocks above their 50-day moving averages, while 82.6% of stocks in the S&P 500 are above their 50-day moving averages. That is an incredibly high reading and indicative of participation from nearly all players in the market.
Have a great Sunday!
Timothy W. Ellis, Jr., CPA/PFS, CFP®
Senior Investment Strategist, Wealth Strategist