Cyclical value stocks have been dumped and growth tech has been in favor since mid-June, creating a wide valuation gap between the two classes of stocks. And one top strategist sees that trend reversing soon, regardless of second-quarter earnings.
Financial results are rolling in and this quarter is widely expected to be the poster-child for the pandemic, with huge earnings declines expected for U.S. companies. But after the U.S. stock market had rebounded from the March 23 low, optimism began to fade as summer got underway. Just after June 8, a nasty sell-off in all sectors of the U.S. took hold. Since that date the Vanguard S&P 500 Value ETF (VOOV) - Get Report, home to, yes, defensive names, but also many cyclicals, is down 5%, even falling as much as10% at one point. The fund’s growth counterpart (VOOG) - Get Report is up 5.8%.
Investors are looking for growth trends that can power through economic headwinds, while shedding the economically sectors. The drivers of that move: a surge in new virus cases, paused reopenings and questions over more fiscal stimulus.
As for the valuation discrepancy, market data on these funds make it difficult to compile a blended earnings estimate for the next year, which one can compare to the stock price. But FANG stocks, many of which have heavy weightings in the growth fund, have powered ahead, gaining about 16% since June 8 on a market cap weighted basis. Earnings estimates have risen for some of these names, but these stocks are on fire. Still, Netflix (NFLX) - Get Report, hot into earnings, said its explosive, stay-at-home-driven subscriber growth, was a mere pull-forward of demand rather than a trend for the future. Netflix had to re-price and the stock corrected, down as much as 10% since earnings. Amazon (AMZN) - Get Report, Microsoft (MSFT) - Get Report, Google (GOOGL) - Get Report and Apple (AAPL) - Get Report are up soon.
Meanwhile, cyclical value, while rebounding a bit in July, is trading at inexpensive earnings multiples, especially compared to interest rates, which are at historically rock-bottom levels.
Economic surprises have also been a theme during the second quarter -- especially in retail sales -- as states reopened and fiscal and monetary stimulus fueled pent-up consumer demand. Many expect Q2 earnings to show solid results and some also expect management teams to highlight improving demand trends in the second half of the quarter. Coca-Cola (KO) - Get Report did just that Tuesday morning.
So given what Q2 earnings may reveal, should cyclicals have a slightly better risk-reward profile than growth tech does? The answer is maybe, but Chief Market Strategist at Cannacord Genuity Tony Dwyer told TheStreet the near-term earnings estimates analysts may revise after Q2 reports don’t really matter much.
“Our call going into the second half of the year is, as we get close to vaccines, we get the economy starting to reopen, you’re going to get a better relative performance coming out of cyclical sectors,” Dwyer said.
“I really don’t think it’s the earnings estimates. Here are the drivers of what’s going to make value outperform: we have an incredible monetary stimulus. We have a Federal Reseve that is literally saying we’re just printing money. We’re going to do it for the foreseeable future. We know that the government is coming up with a second fiscal stimulus package to battle the unemployment rate and the impact of COVID.” Some do note that interest rates can’t go much lower and can’t provide much more stimulus from here -- especially when it comes to stock valuations -- but Dwyer rebutted: “It’s the promise of low interest rates.” He added that, with that promise, comes large sums of new corporate debt and equity issuance, which keeps companies liquid. That drives investors confidence that companies can weather the storm until a vaccine emerges.
Dwyer added, “there’s so much money and you’re just beginning to turn global economic activity."