In the wake of the 2020 election, several COVID-19 vaccine announcements caused the stock market to jump, with no equity seemingly being spared – everything went up.
But as we discussed last week, a pattern started to emerge as investors rotated out of growth stocks and into value/cyclical companies that were the most affected by the pandemic. It makes sense. The news was about a vaccine, and the increases came from firms that would benefit most from a reopening after widespread vaccination.
The rotation can be seen most in the Russell 2000 Index, which is full of small-cap and value stocks. According to FactSet, this month it’s up about 16 percent. Contrast that to the tech- and growth-heavy NASDAQ, which is up 8.6 percent, also per FactSet.
Suddenly “stay at home” stocks are out of favor. So, the question for a lot of investors becomes should tech and growth stocks be on the selling block?
Cornerstone’s opinion is much of the rotation we saw was seemingly caused by quantitative, quick, algorithmic traders who were crowded into growth stocks and shorted value stacks. Thus, when value stocks jumped, these traders were in a mad rush for the exits, especially due to their added leverage in that equation. In other words, when algorithmic traders are forced to sell growth stocks because they're long, they must cover the short on their value stocks.
However, the point is not to lose sight of the big picture, and that is how “big money” institutional investors are still buying everything. What we're seeing in the market’s top-level performance isn’t necessarily reflecting (yet) what “big money” is doing in the investing world’s undercurrents. Per Map Signals’ trusty Big Money Index, there is literally buying top to bottom:
Every sector saw more than 25 percent of its “universe” of stocks bought in an unusually large way. This reinforces our viewpoints that stocks are sold going into elections and bought coming out of them.
In fact, we’d even argue that this is the time to start looking for deals in growth stocks as others, like algorithm traders, are forced to reduce their positions. This also reinforces why we cycled out of our cloud computing positions and lightened our overall tech positions as the fourth quarter started, while adding to value, cyclical, and reopening sectors. These moves were part of our strategic plan, rather than reactive, short-term plots, which would only cost us in the long run.
Speaking of strategic plans, we’d like to take more time to examine investment themes for next year. This time around, we’re going to touch on a couple recently unloved sectors.
High Yield Bonds
With new daily COVID-19 cases hitting record highs and the potential of further shutdowns, many people embrace a worst-case scenario for the stock market. Yet, the high yield bond market (also called the junk bond market) sees light at the end of the tunnel. Remember, the high yield bond market is the most sensitive index to improving and deteriorating economic activity.
An analogy is the high yield bond market is like the tired fellow American who wants to go home for Thanksgiving and is looking forward to the end of the pandemic. Currently the high yield bond spread is at 448 basis points compared to Treasury bonds. For reference, just inside 400 basis points is considered the perfect storm boom territory for high yield bond spreads. So, while we're not right there, we’re extremely close:
High yield bonds are trading more and more like the recession is about to end. Obviously, this attitude in the high yield bond market would not exist without a vaccine and truly not without the Federal Reserve, considering the Fed is buying bonds outright via BlackRock.
But if things act as usual, high yield bonds are a leading indicator to other market cycles. It is reinforcing why we tactically added two high yield bond positions back in the second quarter of 2020, as they will continue to outperform with less volatility as we cycle out of the COVID-19 recession.
Our second 2021 turnaround theme is emerging markets, which have been reliably bearish for the last 10 years (in comparison to the S&P 500). These markets include countries like China, Taiwan, India, Brazil, Saudi Arabia, Singapore, India, the Netherlands, and more.
We theorize that the COVID-19 crisis has helped and will continue to help emerging markets turn the corner. In this chart, the closer the index correlation gets to 0, the better it is for emerging markets:
Emerging markets historically love high inflation, a weak dollar, and strong commodity prices. Well, we don't have all these conditions perfectly now, but they could start to materialize in 2021 and beyond, given the policies the Fed and the U.S. Treasury employed to tackle the pandemic.
We're already seeing that play out this year with strong overall returns in emerging markets. We suspect the latest improvements in that relative performance will stick, resulting in new bull markets in emerging market indexes as the end of the pandemic becomes more visible.
This investment theme is one we implemented at the beginning of this quarter by significantly increasing our emerging market positions. We anticipate maintaining that overweight position within our international sleeve for at least the next 12 months.
Happy Belated Thanksgiving
Lastly, thanks to everyone who reads this blog. We hope you enjoyed your Thanksgiving, no matter what form it took compared to previous years. Hopefully, we all got a bit of time to safely relax and can finish this year strong!
Securities sold through CoreCap Investments, LLC. Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial Services, CoreCap Investments, and CoreCap Advisors are separate and unafﬁliated entities.