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Do Stocks Need Stimulus? Regardless, Here's Where to Look

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U.S. stocks cannot gain much traction until there is more fiscal stimulus. That's widely held view on Wall Street. 

Whenever coronavirus vaccines become widely available and whenever that stimulus comes, the economy will likely benefit greatly and so will stocks most levered to that dynamic. 

This week, the S&P 500 rose just 0.77%, a move lead by large cap tech stocks, as the NYSE FANG-Plus index rose roughly 2%. Take that out of the equation and stocks would have struggled. Large cap value stocks, most of which are sensitive to changes in the economy, were essentially flat for the week. Meanwhile, bond treasury yields fell, with the 10-Year yield down to 0.74% from 0.77%. Markets were risk-off during a week which saw several small news items indicating that fiscal stimulus is likely a post-election affair. 

For small businesses, every day that goes by without fiscal stimulus is a day closer to bankruptcy as re-openings are still far from full. For the many households still unemployed, every day with no form of income makes the consumer less willing to spend in the near future, though backward looking economic data have indeed confirmed consumer spend is still growing and recovering. 

Clearly, stocks need stimulus. And when that stimulus hits, even if the recovery had a period of deceleration, many do expect the economy to return to a mode that would move treasury yields toward 1% and would keep earnings growth ongoing. 

"We're looking for opportunities outside of these large, growthiest, mega-cap stocks that are sitting around the 99th percentile of long-term fair value by our metrics," said Michael Reynolds, Investment Strategy Officer at Glenmede. "We're finding opportunities in value stocks, in small cap stocks and even abroad." 

Value stocks have exhibited some head fakes this year, out-perfoming growth for short spurts of time. Since September 23, the FANG-Plus Index is up almost 11%, with large cap U.S. value up just under 10%. Moreover, the valuation gap between large growth tech and and value reached a margin this year wider than that seen in 2000 before the internet bubble bursted. Even after a September correction in tech, the valuation gap is still wide. 

"We like consumer discretionary going forward as we see a rebound in the economic picture here," Reynolds said. "They should have a high beta to economic data points. Large cap consumer discretionary in the U.S. is down just 2% this year, compared to value's down-move of 9%. And even after harsh selling in value stocks in September, valuations in the sector are not exactly cheap, although Reynolds' viewpoint is most applicable to long-term investors less concerned with their entry points into stocks. Another positive: consumer discretionary valuations, historically, sit at a slight premium to those of the broader market, which should make investors feel comfortable at least adding some exposure to the sector. 

The one counterargument: although FANG stocks could potentially see some valuation compression in the next few years, there are smaller emerging growth businesses that could benefit long-term from the pandemic like video-conferencing innovator Zoom  (ZM) - Get Free Report (up 600% year-to-date) or Slack  (WORK) - Get Free Report (up 45%). These could put your grandfather's value stocks to shame. 

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