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Previously we have discussed “The Four Horsemen of The Recovery” which we see as Stimulus, Economic Data, The Fed, and Vaccine. Before discussing each, it may be helpful to quickly check on stock market performance so far in 2020:
|Growth vs. Value: 2020 Performance By Quarter (to 10/28/20)|
|1Q20||2Q20||3Q20||4Q to date||YTD|
|Index||Change %||Change %||Change %||Change %||Change %|
|S&P 500 Growth||-14.8%||25.7%||11.4%||-2.5%||16.4%|
|S&P 500 Value||-26.0%||12.4%||3.9%||-2.2%||-15.5%|
|Growth less Value||11.2%||13.3%||7.5%||-0.3%||31.9%|
|Russell 1000 (R1K)||-20.6%||21.2%||9.0%||-2.3%||2.5%|
|Growth less Value||13.0%||13.9%||8.1%||-0.3%||35.6%|
|Russell 2000 (R2K)||-30.9%||25.0%||4.6%||2.4%||-7.5%|
|Growth less Value||10.0%||12.0%||5.2%||-0.9%||25.9%|
Clearly, Growth has massively outperformed Value over the course of the year as investors flocked to companies benefitting from the overall transition to “work from home” and the impact of social distancing on leisure and entertainment activities. For example, Gartner reported worldwide 3Q 2020 PC shipments were up +11.4% – the strongest growth in a decade. Google Chromebook sales (not included in the PC data) were up an astounding +90%. NPD data to August shows +23% growth for 2020YTD video game sales versus last year. Also, App Annie reported that hours spent on mobile apps around the world were up +25% percent for Q3 2020 year/year.
Still, we can see in the stock market that Value has been doing better so far in October as the market anticipates an improved economy in 2021. One question to come back to is whether it is time for investors to rotate to Value from Growth.
Now to handicap the ponies, Stimulus has become the football in the political brinksmanship ahead of the November 2020 general election. While there is constant news of negotiations between Congress and The White House, we are reminded of the line from Shakespeare’s “Hamlet” namely, “Words, words, words” which is to say that nothing will happen until after the election with the benefit to come in 2021. The prospects of a Democratic “Blue Wave” election outcome will bring with it the likelihood of a greater fiscal stimulus program, perhaps on the order of $5 trillion with the partial offset being higher income and capital gains tax rates. A mixed election outcome that leaves the Senate in GOP hands will probably be negative for the stock market as the amount of additional fiscal stimulus will be less.
Relative to Economic Data, the news has become mixed since the end of the supplemental unemployment assistance at the end of July 2020. While weekly unemployment claims data have seen modest declines over the past month, we look for spreading COVID infections to put a lid on further employment improvement from current levels. Meanwhile, other high-frequency economic indicators such as the NY Federal Reserve’s Weekly Economic Index (WEI) continue to show generally steady improvement in the US economy. The WEI uses a set of high frequency indicators to evaluate American economic output in almost real-time. These include initial/ongoing claims for unemployment insurance, same-store retail sales, steel production, gasoline and electricity usage, and other data points. For the WEI, the weekly reading is for a -3.9% GDP decline versus the 13-week average of a -5.6% GDP decline.
Relative to The Fed, the indications remain that Chairman Powell is prepared to do what is necessary to continue to provide monetary support for the economy while continuing to reiterate The Fed’s position that further fiscal stimulus efforts are necessary and required for a sustainable economic recovery.
Relative to Vaccine, all indications are that multiple efforts remain underway, but as we have seen the FDA is holding firm on ensuring that necessary vaccine safety protocols are followed prior to remedies being released for wide-scale distribution. Meanwhile, there has been clear evidence that COVID infection rates are accelerating with the onset of colder weather in the Northern Hemisphere. Experts such as Dr. Michael Osterholm, director of the Center for Infectious Disease Research and Policy at the University of Minnesota, state that with infections rising and compliance eroding, “the next 6 to 12 weeks are going to be the darkest of the entire pandemic.”
Bottom line, while the election will soon be passed with a greater stock market upside expected should a Democratic “Blue Wave” be the outcome, the economy is managing to hang in there despite the delay in passing further fiscal stimulus, the Fed is as supportive as ever and COVID still has no vaccine to stop it and the world is falling prey to pandemic fatigue. For the current race among stock market drivers, I put my money on Vaccine to win, Stimulus to place and Economic Data to show.
2) Growth vs. Value: Is It Time For A Rotation?
The ranks of Value stocks are populated with companies whose business models are being disrupted. To that end, the classification should be not Growth vs. Value, but Disruptor vs. Disrupted. When the economy reaches a point where marginal gains start accruing to the Disrupted, then Value will rally. This is a more accurate characterization of the upcoming turn.
Along with the Disruptor vs. Disrupted distinction as superior to the Growth vs. Value classification, we should note the possibility that dividend payouts from Value names are likely to enter secular decline as the Disrupted need to reallocate capital towards self-disruption, much like Disney ($DIS) cutting its workforce and putting funds towards growing its streaming service or like IBM ($IBM) splitting off its growth operations (e.g. AI, cloud and quantum computing). If Value stock dividend streams decline, it undermines their appeal from a total return perspective.
As investors know, the basic equity valuation model is P = DIV / (r – g). If g < 0, then the effective discount rate increases. If that’s a secular phenomenon, then the case for Value stocks suffers as total returns come under pressure. Under this scenario we might say, Value: while not a feasible long-term investment approach, it can be a good trade.
Meanwhile, given the disparate impact of COVID on economies across the globe, whatever normal we return to, it will be one in which the world has been re-ordered. To our view, there is unlikely to be a return to what we had before. While there is an overwhelming tendency over time for reversion to the mean, the question we should address is what exactly will that mean be.
For now, the experience has been that Value outperforms early in the economic cycle when operating leverage rates are highly positive and driving in an accelerated manner operating cash flow levels higher, something underpinning the positive stock market performance of Industrial stocks now. This amounts to a cyclical trading opportunity, but not a long-run core portfolio holding.
In my view, this is reminiscent of the old Wendy’s commercial but the copy has been changed to: “Value: come for the sizzle, but where’s the beef?”
3) Tech Sector Regulation: Senate Section 230 Hearings Offer Grandstanding Opportunity Ahead Of Election
Yesterday’s Senate Commerce Committee hearing was largely a non-event in our opinion as questioning reflected substantial partisan bias with the GOP majority making accusations of bias based factors such as the companies’ geographic location and employees political affiliation.