February 2021 Insights

As the Rotation Continues Value Stocks Out-pace Growth Stocks

  Key Observations:

  • Signs the COVID pandemic is waning and the likelihood of another massive government stimulus package has set the stage for an economic reset.
  • A rotation from growth stocks to value stocks continues, fueled by rising interest rates and valuation concerns for growth stocks.
  • Small-cap stocks continue to outperform on expectations of economic expansion.
  • Inflation expectations are rising, resulting in higher bond yields and commodity prices.

Market Commentary:

The stock market rotation I highlighted in January’s Insights persists as value continues to outperform growth and small-cap outperforms large cap.  In fact, value stocks are having their best month compared to growth in over two decades.  The S&P 500 Value Index is outperforming its growth counterpart by nearly 7% so far in February.  The rotation into small-cap stocks is even more dramatic.  Year-to-date small-cap stocks are up 11.6% versus 2.8% for large-cap stocks.  The economic sectors leading the way are energy and financials increasing 26.0% and 9.5% respectively; both far outpacing technology stock’s 3.3% year-to-date return.  The major catalyst for this significant shift – inflation.

Inflation expectations are growing and are causing interest rates to rise.  The yield on the 10-year Treasury stands at 1.36% having risen by 0.44% since January 1 and by 0.86% since hitting its low in September of last year.  Of course, that’s bad for bonds and the Bloomberg Barclay’s U.S. Aggregate Bond Index is down 2.0% thus far in 2021.  It’s much worse for long-term bonds as they are even more vulnerable to inflation and rising interest rates.  Long-term Treasuries are down 9.5% year-to-date and 6.1% in February alone.  Short-term bonds are faring much better and are basically flat for the year.

Conversely, rising inflation expectations have been good to commodities as many investors view this sector as a good hedge against inflation1.  So far this year, oil is up 27%, copper 17%, Cotton 16% and steel nearly 13%.

Economic Commentary:

We are in the early innings of a significant economic reset.  As reported by S&P Global Market Intelligence2, the pandemic has resulted in U.S. households saving an additional $1.6 trillion.  Think that is a lot of money?  President Biden’s $1.9 trillion stimulus package is moving through Congress and this is on the heels of the $900 billion stimulus package that was passed just two months ago.  That’s nearly $3 trillion of government spending that will be working its way through the economy over the next several quarters.

And if the latest retail sales numbers are any indication, consumers are ready to spend.  Although the surge in Coronavirus cases dampened consumer spending at year-end, the Commerce Department reported retail sales rose 5.3% in January3. This was the largest increase in seven months and was spurred on by the latest round of stimulus checks.  After recent declines, consumer confidence has ticked up.  The Conference Board said its consumer confidence index rose to a three-month high 91.34. Although well below its February 2020 high of 133, we believe that the combination of relief in the form of more government stimulus, progress on COVID vaccinations, and easing government lockdowns should bode well for future confidence readings.

Lastly, we think that pent-up consumer demand combined with unprecedented fiscal stimulus is likely to lead to significant GDP growth in 2021.  The Conference Board estimates 2021 GDP to grow 4.4%5.  Others have even higher forecasts such as Goldman Sachs which recently increased their GDP estimate from 6.6% growth to 6.8%6.

Final Thoughts:

We feel that we are likely in the early stages of a broad economic expansion with rising inflation expectations.  This is a backdrop favorable for a continued rotation from growth stocks into value stocks, especially in the energy and financial sectors.  Economic growth (and certainly getting back to travel) results in sustained higher oil prices and is obviously a boon to oil stocks.  Rising longer-term interest rates, coupled with the Federal Reserve’s commitment to keeping short-term rates low, is also a boon to banking stocks.  This steep “yield curve” is beneficial to banks as they borrow short-term and lend longer-term.  As inflation and long-term rates rise, the profitability of their loans will increase.

Investors reconsidering growth stock valuations are another catalyst for this equity rotation.  During the past several years a modest GDP growth environment has led investors to seek out companies with strong growth in sales and earnings.  This led to substantially higher valuations for growth stocks versus value stocks.  In addition, low-interest rates directed money into the stock market lifting growth stock valuations as well.  A broad, early-stage economic expansion would considerably increase the sales and earnings growth for all types of companies muting the demand for high-priced growth stocks.

Lastly, it is possible expectations of significantly higher interest rates have made stocks less appealing to many investors, especially high-priced growth stocks.  It’s one thing to pay a lot for a stock when bonds are yielding 2%, it’s another when bonds yield 5%.

At Concord Asset Management we consider all this information and more to make informed decisions concerning your portfolio.  If we are convinced changes are necessary to improve your portfolio, we will act in a prudent manner that we believe is in your best interest to help you reach your financial goals.

Sources:
All performance data generated through Morningstar. 
  1. Bloomberg: https://www.bloomberg.com/news/articles/2021-02-22/asian-stocks-to-open-weaker-commodities-rally-markets-wrap
  2. SP Global: https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/consumers-to-unleash-trillions-of-dollars-in-excess-savings-when-pandemic-ends-62511820
  3. Yahoo News: https://news.yahoo.com/u-retail-sales-surprise-sharpest-140716059.html
  4. Market Watch: https://www.marketwatch.com/story/consumer-confidence-climbs-to-three-month-high-as-more-americans-plan-vacations-11614094139
  5. Conference Board: https://conference-board.org/research/us-forecast#:~:text=The%20Conference%20Board%20forecasts%20that,over%2Dyear)%20in%202021.&text=We%20expect%20the%20recovery%20to,over%2Dyear)%20in%202022.
  6. Business Insider: https://markets.businessinsider.com/news/stocks/economic-outlook-us-gdp-2021-forecast-coronavirus-stimulus-goldman-sachs-2021-2-1030059281#:~:text=to%20BI%20Prime-,Goldman%20Sachs%20boosts%20US%20GDP%20forecast%20to%206.8%25%20in%202021,trillion%20in%20COVID%2D19%20stimulus&text=Goldman%20Sachs%20raised%20its%20forecast,trillion%2C%20up%20from%20%241.1%20trillion

    Note: All performance data in the following two charts were drawn from Morningstar.

Disclaimer: Concord Asset Management (“CAM”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where CAM and its representatives are properly licensed or exempt from licensure.

The information provided in this commentary is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

All data is as of the end of February 2021 unless otherwise noted. Data sources include: www.morningstar.com. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

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