Yearend Plays: Tech, REITs, Com Services; Value Over Growth
With about two months of trading left in 2019, investors are in a strange position. True, calendar 2019 has been pretty good, with the Standard & Poor’s 500 Index up a robust 20%. However, stocks continue to hang just below the all-time highs, unable to burst through.
Even though it’s been a good year, that’s in part due to last December’s bear market. So the bear warning cry is reduced to this: The market hasn’t really gone anywhere in 18 months.
That’s true but my base case for the final weeks of this year remains a roughly 3% rally into yearend, taking the S&P 500 above the old closing high of 3026 (July 26) and to around my target of 3125.
How should investors position their portfolios for the next ten weeks or so, particularly given the considerable macro uncertainty, such as the U.S.-China trade tiff, or Brexit, or the direction of rates? My view is based partly on what the market has done for the past 20 years, and on our work on certain potential economic signals.
Since 1999, the best playbook for the last ten weeks of the year has been to stick with the “year-to-date winners” (top 3 sectors), which outperformed the middle five and bottom three sectors. Additionally, the final 10 weeks historically call for a switch from to value stocks from growth.
● PLAYBOOK 1: The year-to-date winners in the top 3 sectors—technology, real estate investment trusts (REITs), and communication services—should show persistence into the yearend by outperforming the market. Over the past twenty years, the outperformance of the three together is 0.4% with a win ratio of 63%. See table below.
●PLAYBOOK 2: Flip to overweighting value stocks. The difference year-todate in performance between value and growth has been a push, but into the yearend value begins to outperform by about 0.3%.
Seasonality of style is surprising to me. Growth stocks tended to outperform value stocks from the start of the year to mid-October, then the market style rotated to value from then to the year end. For the final 10 weeks, value has beaten growth 63% of instances since 1999. It is a flip of the seasonals. See chart below.
What could go wrong? Intuitively, this playbook only works if economic momentum picks up. For the rally to reach “escape velocity” from the market’s flat performance, then a key for this is purchasing manager indexes to be bottoming.
Three factors suggest the US PMIs are bottoming: long term yield curve (discussed many times); key groups sensitive to PMIs are rallying, and ISM New Orders/Inventory looks like it bottomed.
In the first place, as I have pointed out previously, the long-term yield curve is steepening. The long-term yield curve (10-month change of UST 30-yr-10-yr yield spread) signaled 16M ago a downturn in ISM PMI was coming. Since our April 2017 study, the long-term yield curve seems to be doing a pretty good job of predicting ISM. The continued weakness in 2018-19 was predicted 16 months ago and if the pattern holds, then the ISM should be bottoming now with an upturn expected as we move into year end.
Second, PMI sensitive groups are rallying, such as semis (since 5/28), Germany’s DAX (8/16) and capital goods (10/21).
Third, another possible clue is the collapse in the ratio of ISM new orders/inventory. Normally, a collapse in new orders is a foreboding sign, as it points to a collapse in the business cycle. However, if businesses slowed ordering due to “trade shock,” then this is what could be behind the recent plunge. Inventories take time to rebuild.
Bottom Line: My conclusion is that for the final 10 weeks, investors should overweight those year-todate winners and also value stocks. Some stocks to consider: IBM, MXIM, ORVO, INTC, QCOM, PLD, CCI, SBAC, CBRE, IRM, CTL, T, VIAB, DISCK, ATVI, TPR, LEN, EXPE, KSS, PHM, LMT, CMI, ROK, CAT, EMR.
Figure: Comparative matrix of risk/reward drivers in 2019
Per FS Insight
Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
