Follow-ups and New Thoughts:
1) The decline in the 10-year bond yield from 1.74% on March 31st to as low as 1.53% on April 15th has done wonders for growth stocks. Though I don’t believe that the value stock rally is over, it is interesting to note that growth has outperformed value approximately 7% to 3.8% so far this month. Long term bond yields rose way above their upward sloping 50 day moving average in March, indicating that the uptrend had maybe gotten ahead of itself. April’s yield decline took the 10-year right to that average ten days ago, but it has bounced upward in recent days suggesting that the move toward higher rates will continue.
2) As growth stocks have seized leadership back from value stocks this month, so also have large stocks regained the upper hand over small stocks. The S&P 500’s 6% gain has bettered the Russell’s 3.7% gain . I believe you can also attribute this to moderating interest rates and the concern that second half economic growth may not quite be the blow-out everyone expected a month ago. This belief has also been borne out by a 3% dip in the U.S. dollar, erasing more than 75% of the first quarter gain. I do not believe the small cap rally is over either; sometimes a rally just needs to consolidate a bit.
3) Morningstar’s style box invention was revolutionary when it came out because it helped users understand that market capitalization and investment style could have a dramatic impact on performance. From my observations, they could go a step further. I believe that there is a big difference on the growth side between momentum growth, in which one selects for the fastest growing companies regardless of price, and growth-at-a-reasonable-price, where one computes a “PEG” ratio, or P/E to growth, to determine if one is paying too high of a price for future earnings growth. Last year there was tremendous out-performance on the part of momentum-oriented stocks (many of which, like Uber and Twitter, had yet to turn a profit). This year has favored the type of growth funds that own only profitable companies and whose P/E multiples are not unreasonable given current growth rates.
On the value side, one could separate the stocks according to whether they were cyclical value plays, where the attraction is their leverage to earnings recovery as the economy moves from recession to expansion, and defensive, where the stability of the underlying business, its yield and its relatively reasonable price provide something of a cushion when the economy is weakening. Typically, defensives do better throughout the economic cycle until the economy moves out of recession into early expansion. In that one phase, cyclical value outperformance tends to be dramatically better.
I like to have at least one fund/ETF of each type in my portfolios. I may adjust the weighting a little bit depending on where I think we are in the economic cycle.
4) Following on the idea of economic cycle rotation mentioned in the previous section, we may be at a point where cyclical value gives way to defensive. Many deep cyclical companies have seen their prices double or more from last year’s lows. Engineered wood products maker Louisiana Pacific (LPX) has gone from a pre-Covid peak of $33 to a pandemic trough low of less than $15, before rebounding to $69 today. Sometime soon, investors are going to book profits in companies like LPX. If you anticipate where deep cyclical money might be heading, it might be the real estate sector. Real estate has been a little under the radar as investors were concerned for a long time about whether the work at home crowd would ever come back. Even with its recent rally real estate still trades below its early 2020 all-time high .
5) With many of China’s leading firms currently out of the good graces of the ruling government, emerging markets funds have struggled a bit since February. The best EM performance recently has come from the smaller capitalization funds and ETFs. Until the cloud lifts from companies like Tencent and Alibaba, smaller cap ETFs like FEMS and EWX and funds like WAEMX are probably going to continue to perform better.
6) My final point would be this: Seasonally the stock market tends to do less well from May through September. That doesn’t mean it will happen this year, but as I write this the S&P 500 is up about 12% and small caps have done even better. Having already exceeded the usual yearly return, it wouldn’t be surprising to see stocks consolidate a bit over the next few months. If you consider that continued year-over-year gains in inflation are probably going to put more pressure on the Fed, you can see where the liquidity environment for stocks might get a little less favorable. I don’t think this is the time to increase one’s risk exposure.
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[i] From April 1 through midday, April 29th, per Y Charts
[ii] Source: Y Charts as of midday, April 29th