Almost every large group of stocks highly sensitive to changes in the economic landscape is hanging around correction territory. Some are in bear markets. That big market drawdown so many have been waiting for has happened, but you would never know just by glancing at the S&P 500.
Thursday, the S&P 500 did fall by as much as 1% because, for once, tech stocks stopped rising. The Nasdaq was largely flat for most of the day. Continuing a larger trend since mid-June, cyclical groups of stocks were falling considerably, leaving the S&P 500 to drop off, albeit not to an extreme because tech stocks have an outsized weighting in the S&P 500.
In May, value stocks, many of which are in cyclical sectors of the economy, made a comeback. In the past week, they’ve hung in there with the exception of Thursday and certainly not since mid-June. The past week has featured some optimism that, even though coronavirus cases in the U.S. are soaring and even though states are halting reopening plans, Congress and the White House seem ready to deploy more fiscal stimulus. Monetary stimulus is flowing through, but interest rates can’t go any lower and the Federal Reserve is unlikely to move to negative rates. The Paycheck Protection Program -- round one -- seemed instrumental in moving unemployment down a bit. Cash injections to households seemed instrumental in supporting consumer spend. bringing to the reopenings that are now slowing.
But fiscal stimulus will not continue forever, and lockdowns are once again an option for some governors at this point.
Since June 8, the S&P 500 is only down about 2.5%, but a closer look at the composition of that move paints a much bleaker picture than the slight down-move. June 8 marked a high point for the S&P 500 since the bear market low of March 23.
Let’s explore some sectors and classes of stocks since June 8.
Vanguard S&P 500 Value ETF VOOV: -10.5%
There are defensive stocks in this ETF, but there are also tons of cyclicals, dragging the fund down.
S&P 500 Consumer Discretionary Index: -14%
Large fast food brands like McDonald’s (MCD) - Get McDonald's Corporation Report and Starbucks (SBUX) - Get Starbucks Corporation Report have certainly contributed to the downside, even though they have strong digital businesses that prevent sales from completely falling off a cliff. But helping bring the index down are the stocks of companies that are on life support because they have no performance hope at all during a pandemic and recession. United Airlines (UAL) - Get United Airlines Holdings Inc. Report is down 37% since June 8, a bear market. Since then, Darden Restaurants (DRI) - Get Darden Restaurants Inc. Report is down 16%. Marriot (MAR) - Get Marriott International Report is down 23%, a bear market.
Russell 2000: -8%
That’s almost a correction, but not quite. Small caps have been particularly challenged and are far more beneath their all-time time highs than S&P 500 stocks are for several reasons.
First off, smaller companies can be more impacted by economic turbulence sometimes because they don’t have size and scale. Sometimes, they are looking to grow and economic headwinds that disallow them from reaching growth potential can send earnings estimates reeling.
Moreover, many of them carry heavy debt burdens, so any hit to revenue and earnings puts them in a highly vulnerable financial position. And commercial bankers TheStreet has spoken with have said this year that small companies can have limited access to debt financing that can keep them afloat during rough times because these companies can’t routinely access big lenders. Instead, they have to privately negotiate with smaller lenders, like direct lenders or debt funds.
But during market turbulence, sometimes investors sell off stocks that maybe do not deserve the kind of negative price action they are getting.
Equity strategists at RBC Capital Markets, in a note outlining their top small-cap picks, highlighted a few consumer names that have plummeted and could have substantial upside. "In Consumer, we highlight Canada Goose (GOOS) - Get Canada Goose Holdings Inc. Subordinate Report on the strength of its lifestyle brand and Primo Water (PRMW) - Get Primo Water Corporation Report for its faster- growing higher margin business that should benefit in a post-COVID world,” RBC wrote.
The $2.4 billion Canada Goose is 27% below its all-time-high of $35 and down 16% since June 9. It’s trading at 19 times 2021, or normalized, earnings per share, against a trailing 5-year average of 41 times. RBC has a price target of $47, representing more than 100% upside. Goose has negative net debt, which means it has more cash than debt and is in solid financial position, but investors may still have been uncomfortable buying more Goose over larger cap stocks, which may still have more financial flexibility. Yes, Goose’s products are highly discretionary and not prioritized in household budgets during a lockdown-induced recession. But RBC emphasized not just Goose’s strong balance sheet but also its long-term growth trajectory in outerwear.
Other small caps to feel the burn are oil smaller companies, many of which carry very heavy debt burdens, especially as the price of oil has had a horrid 2020 and even an awful 3-year run.
Occidental OXY: -33%
Halliburton HAL: -31%
Apache APA: -29%
These are all bear markets. Occidental’s (OXY) - Get Occidental Petroleum Corporation Report debt burden is tremendous, with net debt-to-EBITDA of 5 times on normalized 2021 figures. That’s debt minus cash as a multiple of earnings before interest, tax, depreciation and amortization. A healthy ratio is usually around 2 times. Occidental’s total debt of $35 billion is several times its market cap of $14 billion, leaving 70% of its total enterprise value in debt. The other two tickers are (APA) - Get APA Corporation Report and (HAL) - Get Halliburton Company Report.
Russell 3000: -2.8%
Anyone holding anything that mimics the index has outperformed the U.S. indices since June 8.
Energy Select Sector SPDR ETF XLE: -26%
That’s a bear market. Oil (XLE) - Get The Energy Select Sector SPDR Fund Report is highly economically sensitive of course and investors are implying that they’re not completely comfortable buying stocks that need a high degree of economic activity currently.
Invesco KBW Bank ETF KBWB: -31%
That’s a bear market. Banks (KBWB) - Get Invesco KBW Bank ETF Report had a solid run in May, as many cyclical value stocks did as well. And banks had underperformed the S&P 500 in the first leg of the relief rally in April. Interest rates expanded for some time and the 10-Year Treasury yield shot up to 0.91% during early June’s bullishness from a 2020 low of 0.4%, expanding the yield curve. But since June 8, the spread between the 2-year and 10-year treasuries has fallen from 0.67% to 0.45%. Banks borrow short-term and lend long-term, so the spread shows a banks’ profit per loan. Of course, lower rates help spur lending volumes, but banks need a decent margin and the low rates are reflecting poor economic demand and inflation expectations, a negative indicator for loan volumes. Some regional banks, less diversified from lending, are getting hit harder than large cap banks.
Meanwhile investors are looking for growth tech stocks wherever they can find them, as some of those companies can power through economic headwinds with their strong secular trends.
Vanguard S&P 500 growth ETF VOOG: +1.2%
NYSE FANG Index: +11%
Apple (AAPL) - Get Apple Inc. Report and Amazon (AMZN) - Get Amazon.com Inc. Report specifically are seeing higher earnings estimates. China’s rebound and some U.S. reopenings leads a strong 5G device cycle potentially for several years. Apple’s app store and other services are seeing a stay-at-home tailwind, moving some analyst’s estimates on services from 20% annual growth to 30%. Amazon’s e-commerce and cloud business are seeing huge tailwinds. One-year earnings are expanding for these companies, as are their earnings multiples.
iShares PHLX Semicondutor ETF SOXX: +4%
Semiconductor’s (SOXX) - Get iShares PHLX SOX Semiconductor Sector Index Fund Report are a mixed bag in terms of cyclicality, product segments and growth-like characteristics. But some of the largest holdings in this fund are highly exposed to the secular trends of 5G devices and data centers, which power the cloud.
The point: investors are actually not so bullish on economic and virus-related prospects. They have been bullish in some pockets of time, but the shiners of this market have been those that can succeed in seemingly any environment. Now is the time to pick carefully out of the oversold losers and the overbought winners.