Buy Epicenter Stocks for the Skepticism, Stay for the Growth
Unfortunately, daily cases are up again in the US, with the same four states accounting for the bulk of cases: CA, TX, FL and AZ. I don’t think the states need to roll back the eased restrictions because the case surge timeline fits with the nationwide protests more than it does with the easing of state restrictions. See Point 1.
Five recent studies show how effective masks can be to slow COVID-19 transmission. Mitigation steps, like requiring masks can enable the safe re-opening of the US and allow more “V”s to appear throughout the economy. See Point 2.
I still see stocks in the hands of buyers and the latest BofA Merrill Fund Manager survey supports this. The most under owned sectors remain Epicenter groups: Discretionary, Financials, Energy and Industrials. These four are just 26% of market cap, but 62% of future EPS growth. See Strategy, next page.
POINT #1: Total USA cases are showing a stubborn rise in cases. This is not due to a rise in testing, and less to easing of restrictions. The recency of the surge fits with cases rising due to the >350 nationwide protests raging for ~3 weeks now.
While many may see this as an indictment for easing economic restrictions, I believe a “course correction” is warranted. Moreover, hospitalization and death trends are not rising in tandem with cases, a positive. A simple policy response could mitigate transmission — requiring masks. And CA, TX and FL took some “course correction” steps, including the use of masks. That’s a positive.
POINT #2: Multiple studies show masks reduce spread, with as little as 40% of population usage. California is the latest state to course correct, requiring the use of masks when interacting with other people in public. Under the new guidelines, the rules essentially require a mask whenever someone leaves their home.
Recent studies show the benefit of masks in reducing virus spread and does not require 100% compliance. The conclusion is that wearing a mask for the infected, pretty much prevents spread… even on long flights. A simple cotton mask reduces 96% of viral if a COVID-19 infected coughs 8 inches away.
If everyone had a medical mask, then only 40% of the population needs to wear a mask to keep R0<1.0 (R0 tells you the average number of people who will contract a contagious disease from one person with that disease.) If masks are only 60% efficient, the percentage of compliance only needs to be 60% This is pretty impressive. Basically, there is not a need for 100% compliance. In Asia, mask compliance is in the 70%-range and at that level, the R0 is way below 1.0.
POINT #3: Given the economic cycle likely bottomed, we have been advocating investors Overweight “Epicenter” sectors: Discretionary ex-AMZN, Financials, Energy and Industrials. We like Technology and the US economy will be more technology-centric post-COVID-19, but Tech is an obvious and consensus overweight
Who’s doing the heavy lifting for earnings growth in both 2021 and 2022? My model estimates show (see chart) the largest contribution from Epicenter, or Financials, Industrials, Materials, Discretionary, and Energy. Secular Growth is Tech, Healthcare and Comm Services. Defensives are REITS, Utes and Staples.
The Street estimates are for $163 SPX EPS next year, versus my $190. Even so, the Street projects 62% of EPS growth to come from Epicenter in 2021, similar to my expectation, or twice that of secular growth. But Epicenter is only 35% of the Street’s secular growth in 2022 compared to my 60% growth view.
In 2021, thanks to operating leverage, I see this Epicenter EPS contribution continuing. Epicenter groups are all expected to see considerably higher topline growth than the S&P 500 overall, except for Financials (6%). Energy is forecast to be highest at 17%
STRATEGY: Buy for the “skepticism” and stay for the “growth” — 32 stock ideas. Over the past few weeks, when equities are risk-on (rally mode), we’ve seen outperformance of the Epicenter sectors. This differs from the rally we saw in late-March/ early-April where secular growth (Tech, Comm Services and Healthcare) led. Thus, if investors are risk-on, epicenters are at the center of that rally.
The latest BofA Merrill Fund Manager Survey shows “Epicenter” is underweighted (see chart), with Energy extreme at -1.5 standard deviations, showing that Epicenter sectors are still consensus underweights. The exception is Discretionary, which has shifted to a slight OW. Risk/reward is arguably better when the consensus is underweight a group. If that sector is not owned, then positive news would prompt a positive change in positioning = upside.
Our team has found the “intersect” of stock ideas within the Epicenter + Technology. There are 32 stocks in the Russell 1000 that meet 3 of 3 criteria: 1) Ranked DQM quintile 1 (quant model); 2) Rated OW by Brian Rauscher, Head of Global Portfolio Strategy and 3) Rated OW by Rob Sluymer, Head of Technical Strategy. Discretionary: GNTX, BBY, GRMN, TPX, DHI, LEN, EBAY; Energy: CVX, XOM, COP, PXD Financial: GS, MS, SBNY, SIVB; Industrials: GD, ALK, FBHS, MAS, CMI, OSK, ITT, GWW, MSM, SNDR; Technology: MXIM, OLED, XLNX, MSFT, AAPL; Comm Svcs: GOOGL, Z.
Figure: Comparative matrix of risk/reward drivers in 2020
Per FS Insight
Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
