Despite a promising start to the week with the first day below 50,000 new cases, progress seemed to reverse. We discuss four potential reasons that could explain the upward tick. Firstly, it could be a result of some schools being on spring break and the associated increase in travel. The second and most concerning explanation is that more transmissible variants are gaining ground. Thirdly, it could have to do with the inclement weather potentially affecting immune systems. Finally, disruptions last week also associated with the weather may have created a backlog in testing that is only now being realized.
Whatever the reason behind the current uptick, we think it’s too soon to render judgement right now. However, it seems our prediction of sub-25,000 cases in March may be delayed. Despite, this new development we are very positive on the progress of vaccinations. By our calculations, 7 states have now reached the level where combined vaccinations and infections are reaching the critical level of 60% where ‘herd immunity’ may begin kicking in.
The volatility in the stock market this week was nothing compared to what happened in the bond market as yields moved up to their recent highs in quick fashion. Equities suffered a sizeable setback Thursday and Friday as Tech and Communication Services gained back some of the ground it lost while rates stabilized.
Still, as we pointed out above, the rotation into ‘Epicenter’ stocks has been the main theme since the year began. Even with this week’s setbacks the Energy Sector, or the ‘Epicenter of the Epicenter’ as we referred to it this week is up by more than 30% YTD, followed by Financials at 11%. Still, despite the fact that some energy names may appear overstretched by some measures, we think the historically low weighting and the fact that institutions will soon need to start re-allocating into this sector in order to provide acceptable returns to their investors should result in institutional FOMO that results in prices continuing to climb.
This is why we are still very bullish on ‘Epicenter’ and think you should be tilting exposure away from ‘Growth’ and toward the 37% of the market that has been neglected because of uncertainty and commercial interruption. When we examine the data from the latest BofA Global Fund Manager Survey it supports our thesis. Institutions are severely underweight a sector that has been significantly outperforming YTD.
Energy isn’t just unpopular right now despite its superior performance as of late. It is the 3rd most popular UW, second only to cash and bonds. In fact, the survey shows that institutions added to cash this past month and increased their UW in Energy. There’s only so much alpha to go around, the secular picture for energy from supply/demand picture and commodity prices seems to suggest strength and pretty soon here something will have to give and a lot of folks will have to re-allocate into energy quickly.
The pandemic has been defined by over-spending, by historic standards, on goods instead of services. Many services were simply unable to be purchased due to lockdowns and the social effects of the virus. Life is going to change dramatically when the pandemic recedes enough for interrupted activities to resume. Here are some ways to think about coming economic re-opening. Theme parks will be booming, should I buy Netflix? Nope. People will be flooding back to gyms and gathering places as well as traveling so you probably want to own some cyclical names in place of Peloton or Zoom.
So you can see, there will be a shift in the mindset of both consumers and investors as we move through mid-year and it will show up as what portion of the consumer wallet is going where. It’s been skewed toward online in recent months, it will likely skew toward experiential, travel and the ‘smoke-stack’ names necessary to make that travel happen in the coming quarters.
Overall, despite the market turmoil this week we do not think the case to be cyclically tilted has weakened, if anything we believe it is stronger than ever. The vaccine rollout is set to dramatically accelerate, the US economy is re-opening, US corporates reset cost structures which means they’ll have historically strong operating leverage. US credit markets are strong and the balance sheet of the US consumer is also strong.
In addition, while history doesn’t necessarily repeat itself, we did some analysis on the last times over the previous decades that interest rate volatility was this severe and what it meant for stocks. The results are enlightening and suggest that markets have shaken out some of the frothiness and are poised to resume their move upward in anticipation of broad economic normalization.
Bottom Line: Despite this week’s volatility it is still early in the rotation from Growth to ‘Epicenter.’ The spike in bond volatility suggests a bottom may be near. Check out our ‘Epicenter Trifecta’ stock list.
Figure: Way forward ➜ What changes after COVID-19
Per FSInsight
Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
