The Bull Market Rotates Away From Tech-Driven Mega-Companies
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TheCovid-19 pandemic has done tremendous damage to the U.S. economy—especially the parts that can thrive only when people are willing to leave their homes and spend some money. But the way Michael Baron sees things, “it can’t flatten Vail Mountain.” The famous ski destination “is still there, and people are itching to go away,” says the co-manager of theBaron Partners Fund, which owns shares ofVail Resorts. “There’s a lot of pent-up demand for leisure travel.”
This type of thinking has been dominating Wall Street in recent weeks. The economyisn’t really back, but the market is ready toassume it will be. Andpromising vaccine developments have investors betting on the companies they think will benefit the most from a return to normal. Vail Resorts—a longtime holding of the Baron fund—rose almost 19% in November, compared with about 11% for the S&P 500. Before November, Vail had been lagging the S&P in 2020.
Investment pros are calling this a long-awaited rotation: away from the technology-driven mega-companies such asAmazon.com,Facebook, andAlphabet that have been the undisputedstars of this bull market and toward the B team of … well, almost everything else. Besides cyclical sectors of the market that rise and fall with the economy, such as travel, leisure, energy, financial, and industrial companies, the rotation has also meant better performance from smaller companies and non-U.S. stocks.
Value stocks—that is, those that typically trade at low prices relative to their earnings—are particularly hot. The Russell 1000 Value Index just completed itsbest month ever with a 13% gain. Its counterpart index of high-priced growth stocks gained 10%. Meanwhile, the Russell 2000 Index of small-cap companies rallied 18% in November. Exchange-traded funds that invest in financial companies saw their biggest month of inflows since 2016, while those tracking industrials received the most since January 2018, and energy ETFs took in the most new cash since March as oil rebounded to a more than eight-month high on Nov. 25.
At its heart, the rotation is based on the idea that there’s a lot of money in the economy waiting to be spent on things besides video streaming and online shopping. The U.S. personal savings rate was 7.2% at the end of 2019. By April it had surged to 33.7%, and it was still 13.6% in October—almost double where it started the year. Deposits at U.S. commercial banks swelled to almost $16 trillion in November, up from $13.2 trillion at the end of last year. If consumers revert to their pre-pandemic ways, that could set off what Jim Paulsen, chief investment strategist for theLeuthold Group, has called “a growth bomb,” as companies gear up to replace lean inventories.
Fund managers with avalue bias say there are still opportunities to take advantage of the change in investors’ tastes. Chris Davis ofDavis Funds points to the banksWells Fargo & Co. andCapital One Financial Corp., whose prices were hammered when lockdowns began in March and still haven’t fully recovered. Davis thinks investors have overlooked how banking regulations enacted after the global financial crisis have made these lenders better able to handle recessions. “When you look at their valuations, the amount of cash they produce, the capital ratios that they have, the reserves they’ve been able to put up—they really have this characteristic of resilience and durability, and yet are priced at this sort of shockingly low level,” he says.
The star money managers of the growth-stock world, who rode the outperformance of tech to dazzling returns, have also taken notice of the shifting mood. Cathie Wood, whose firmARK Investment Management runsthree of the top 10 best-performing ETFs this year, said in a recent webinar that an economic recovery “may benefit many value sectors in the short term.” But she argues that even without a pandemic, many traditional industries are still vulnerable to being displaced by new technology. “The value world will be a little bit of a minefield,” she said.
Wall Street has heard the rotation song before. What looked for a moment like some durable rotations from growth to value in recent years ended up fizzling out. And rotations don’t typically occur in a perfectly orderly way—on some days the changes in market leadership make it appear as if investors are once again more worried about the virus, rather than optimistic about vaccines. There’s still a difficult winter and a U.S. presidential transition ahead, and the economy could sustain more damage than investors are counting on if Washington doesn’t come up with additional economic stimulus and aid for laid-off workers.
So how long might this shift actually last? “Everyone has been trying to time the growth-to-value trade for years now,” says Dave Wagner, portfolio manager and analyst atAptus Capital Advisors. This time around, he thinks the economic turnaround brought about by a vaccine could be enough to make a rotation stick. “Unlike the past few times we’ve seen, there’s a better backdrop for value,” he says. “You have a longer runway that can continue to drive value forward in the future, more so than growth.”
Rob Arnott, the founder of investment adviserResearch Affiliates, has for years been a steadfast advocate for stocks with low valuations and a skeptic of the growth-stock boom. “And so I’ve been called a perma-bear,” he says. “But I love stocks when they’re cheap.” Until pretty recently, that’s been a tough stance to hold: Over the past decade, the Russell index of value stocks has lagged growth stocks by an annualized 6.7 percentage points. But Arnott says when value is in style, it can dominate for a long time. After the tech bubble burst 20 years ago, the Russell 1000 Value Index did better than the Russell 1000 Growth Index from March 2000 until August 2006. “The original tech bubble in 2000—how many of the 10 largest market-cap tech stocks beat the market over the next 10 years?” he asks. “Zero. Not one.”
One big difference from 2000: Growth and tech stocks aren’t exactly on the ropes—they just haven’t been the fastest risers in recent weeks. Still, Arnott thinks that, much as in 2000, investors may finally be starting to see growth stocks as overpriced and value stocks as the better deal. “I do think we’re going to see somewhere between impressive and stupendous outperformance for value over the next three to five years,” he says.
The technology bulls remain unflustered. Vance Howard ofHoward Capital Management, which has bet big on the tech-heavy Nasdaq 100 Index, says tech stocks are still doing well enough compared to value to suggest that market sentiment hasn’t switched yet. He thinks some of the hype around the rotation is a result of value fund managers who missed out on most of this year’s rally and need a story to tell clients. “A lot of managers want to start preaching their book because they’ve got to make up a reason why they’re down,” he says. But for now, at least, investors who’ve taken the road less traveled have some good numbers to brag about.
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