US value and cyclical stocks continue to be strategists’ favourite pick on multiple supportive factors while expected rotation outside of the United States did not go well due to divergence of economic recovery outlook in major economies.
US value and cyclical stocks, which benefit hugely from economic recovery, are catching up in relative valuation versus growth stocks, which outperformed at the height of the pandemic.
Dow Jones Industrial Average index gained 3,6 percent in last month while Nasdaq index fell 4,75 percent in the same period, as US new stimulus package stoked optimism on recovery with growth stocks hurt by rising long-term Treasury bond yields.
Value, cyclicals take leadership
The shift in equity leadership toward last years’ laggards has been given a further boost by the passage of the US$1,9-trillion-US-dollar economic stimulus in the United States, said Mark Haefele, chief investment officer of UBS Global Wealth Management.
Rising bond yields have contributed to the strong performance of value stocks relative to growth and technology stocks, said Haefele.
US cyclical sectors like energy, financials, industrials and materials have led the market higher since early November 2020 when positive vaccine news began to trickle out, said research firm MRB Partners.
MRB Partners said it expects cyclical sectors to continue to exert market leadership in the year ahead given the prospects of strong economic rebound once a large share of the population is inoculated.
With inflation, stimulus and an accelerating economic expansion all at play, “we think investors should still be positioned tactically for a continuation of the ‘reflation trade,’ particularly in energy, financials, and small caps,” added Haefele.
Haefele noted that these above-mentioned sectors should all benefit from a more robust economy and higher yields, which are likely to continue to create near-term volatility and uncertainty for some growth stocks.
In the phase of strong inflation, small caps and value stocks have typically outperformed large caps and growth stocks, and the profits recovery and economic rebound this year would provide further support to the trend, said Bank of America Global Research recently.
Value, small cap and international equities are favoured over growth stocks for a cyclical recovery, said Barry Bannister, head of institutional equity strategy with US brokerage and investment banking firm Stifel, on Thursday, adding that value stocks are breaking out after deep under performance in near four years leading to September 2020.
Supportive factors for the breaking out include a levelling dollar, gradual reflation, a rising 10-year Treasury bond yield, a topping out of stock market valuation and penetration measures, rising US broad money supply and commodity upturn developments, according to Bannister.
In the base case, the rotation into value and cyclical will continue in the near term with the support of broadening recovery and faster growth, said Haefele.
Value stocks could outperform growth stocks by 40 percent cumulatively from the fourth quarter of 2020 to the third quarter of 2024 with the help of a cyclical commodity recovery, said Bannister.
Haefele said of a new paradigm consisting of sustainable high nominal growth and higher yields emerges, “the value trade could run for years.”
Investors should take the opportunity to build some exposure in value stocks, both for near-term performance and as a hedge against a potential change in the market regime, according to Haefele.
US equities could rise further
The US equities look still attractive versus the bonds and a number of overseas equity markets, though the elevated valuation of U.S. equities raises concerns about bubble.
In the base case, the S&P 500 index has a target price of 4 200 points by December 2021, up from closing of 3 913,1 points on Friday, and total earnings per shares with S&P 500 index members will rebound to US$182 in 2021 and US$205 in 2022, respectively, according to the UBS.
Member companies under S&P 500 index had total earnings per shares of 122,37 dollars, according to the latest estimate by Howard Silverblatt, senior index analyst with S&P Dow Jones Indices.
Bannister said if the Federal Reserve ever explicitly represses the nominal and thus real 10-year Treasury bond yield, that would risk a major equity bubble so long as inflation remain low.
A bubble could quickly add cyclically adjusted price to earnings ratio (CAPE) by 11 multiples, leading the S&P 500 index soaring to around 5 300 points, according to Bannister.
Haefele added that equities still are attractive for longer-term investors as dividends alone from S&P 500 index are likely to offer higher returns than bond coupons from US Treasuries in the next decade.
In addition, divergence within the technology sector and headwinds from rising bond yields don’t mean this is the beginning of the end for tech investing, according to Haefele. — Xinhua.