PODCAST: A Brighter Future with Laidlaw, Episode 32 – As New Bull Market Starts With Record Cash Inflows, Time To Ride Small Caps?

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In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, discusses the start of a new market cycle, the marriage of technical and fundamental analysis in examining market leaders, the “FAANMG,” the “Growth Scare” reflecting the lack of further fiscal stimulus to contain the damage to the economy from COVId, how investors should approach investing in international markets, how tightening high-yield bond spreads provide confirmation to the rally in the Russell 2000 and other developments with Laidlaw & Company Chief Market strategist, David Garrity.

The topics discussed in this episode are: Just how significant was last week’s +6.07% move in the Russell 2000?, With rotation from Growth to Value is it time to sell out “FAANMG” positions?, With no further fiscal stimulus and COVID resurging, is the “Growth Scare” justified?, If investors want to invest internationally, what looks attractive now? and  Should investors consider high-yield credit as an area for possible concern? 

Please tune in for more timely insights.


Hello and welcome to another episode of “A Brighter Future,” Laidlaw & Co’s Podcast Series.  I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and once again I am joined by David Garrity, Chief Market Strategist for Laidlaw & Co. 

David, last week we saw the S&P 500 close at a new record high and global equities post a second week of gains following news of progress in developing a COVID-19 vaccine. In fact, when we were taping A Brighter Future last week, we were still digesting the Pfizer/BioNTech announcement that their vaccine had 90% effectiveness in their large study which triggered a new wave of hope and optimism that a medical solution will address the health crisis and accelerate the economic recovery.   

We saw cyclical sectors that had been negatively impacted by the pandemic and are more sensitive to the reopening of the economy outperform last week, while sectors that have benefited from the pandemic like the “Work From Home” stocks, underperform.  A similar rotation occurred across asset classes, with small-cap and international stocks outpacing U.S. large-caps.  

The encouraging vaccine news is consistent with what we have been saying, that the economic recovery will be sustainable heading into and through 2021, but near-term uncertainties could still trigger volatility. 

Mass production and widespread distribution of any vaccine will likely take months, and in the meantime the virus will continue to shape the direction of the economy, suggesting that balance and diversification across sectors and asset classes are warranted. 

And it’s that balance and diversification where I want to start our discussion today…    

Rick, with all the violent swings in the market over 2020, we need to be able to step back and assess the broader outline of the stock market. To that end this weekend I travelled with family up to the Presidential Range in New Hampshire. While usually starting to be covered with snow at this time of year, Mount Washington and the surrounding peaks were bare. In our hiking, we could make out clearly the easier paths and steeper slopes that might otherwise be obscured by the groundcover.  

So too, the last week has opened some interesting perspectives on the stock market as small-cap Value stocks in the Russell 2000 rallied +9.23% and large-cap Growth stocks in the Russell 1000 retreated -1.18% as the Pfizer COVID vaccine news prompted a major rotation from Growth to Value. 

To capture this in the broader context of market shifts in 2020, we offer the table below which shows that Value stocks across the capitalization spectrum are -6% below their 52-weeks highs while Growth stocks have exceeded theirs by +11-18%. With the possibility that there may be a vaccine for COVID, the risks around Value stocks are starting to be mitigated.

Growth vs. Value: Performance from 2/19/20 Peak 
 2/19 – 10/3010/30 – 11/132/19 – 11/13Recover %
IndexChange %Change %Change %Of Peak
S&P 500-3.4%9.6%5.9%106%
S&P 500 Growth6.7%8.5%15.8%116%
S&P 500 Value-15.9%11.4%-6.4%94%
Growth less Value22.6%-2.9%22.1%22%
Russell 1000 (R1K)-2.6%9.6%6.7%107%
R1K Growth9.0%8.1%17.8%118%
R1K Value-15.5%11.4%-5.9%94%
Growth less Value24.5%-3.3%23.7%24%
Russell 2000 (R2K)-9.1%13.4%3.0%103%
R2K Growth-0.9%12.5%11.4%111%
R2K Value-18.3%14.5%-6.4%94%
Growth less Value17.4%-2.1%17.9%18%

Our thought last week that a new bull market cycle might form as we move past the election certainly received a positive response last week as, according to the FT, “investors ploughed more into global stock funds in the days after Pfizer unveiled its virus breakthrough on Monday than in any week in at least two decades, as the news electrified financial markets. Funds that buy stocks counted +$44.5bn of inflows in the week to Wednesday, including more than +$32bn that was invested in US stock funds, according to the data provider EPFR Global. It was the largest weekly haul by equity funds since EPFR has been collecting the data, as well as the second-biggest intake by US stock funds since 2000.”

Yes, indeed, Rick, it appears investors are making a downpayment on a bull market in 2021 and are looking for the market to scale to new heights.

Question 1:

Barron’s recently interviewed Louise Yamada, someone who I have followed since my days @ Smith Barney.   Louise is one of the leading Technical Analysts on Wall Street and she sees the “FAANMG” tech leaders making tops and being vulnerable to declines of “bear-market proportions.”   

She goes on to say that since big tech is in essence supporting this market, if they give way, a cycle-ending structural bear market will erupt because a key tenet of technical analysis is that a bull market consists of higher highs and higher lows.  

But, the “FAANMG” stocks have made lower highs and could be headed to breaking support.  In addition, the vaccine news sparked a rotation last week, providing a boost to pandemic laggards, while pandemic leaders trailed. 

Technology, growth, and so-called “stay-at-home” stocks, strong outperformers during the rally since late-March took a back seat to  stocks that perform well in more normal economic conditions like cyclical, value and small-cap shares.

So is now the time for our listeners to consider:

 1) Taking some profits in names like AMZN, NFLX, FB, AAPL, MSFT and GOOGL and 

2) Moving those proceeds into financials, industrials, energy and maybe some small cap?

Rick, as I am also a Smith Barney alum, I too have appreciated Louise Yamada’s technical analysis insights as well as those of her colleague Alan Shaw for quite some time. Yet while technical analysis helps to provide a framework to define the boundaries of possible stock price moves, I believe the fundamentals still serve to drive the final outcome in terms of share price developments. 

To that end, it is important to bear in mind that COVID has had a significant and enduring effect on consumer behavior. According to the WSJ, “The pandemic’s disruptions have transformed how American consumers behave by accelerating their embrace of digital commerce, and the changes are likely to prove permanent, according to businesses studying and adapting to the changes. A recent survey by consulting firm McKinsey & Co. found that about three out of four people have tried a new shopping method and that more than half of all consumers intend to continue using curbside pickup and grocery-delivery services after the pandemic is over. Nearly 70% of consumers surveyed intend to continue buying online for store pickup.”

While good news on COVID vaccine developments offer reassurance, bear in mind that it will take time and considerable effort to bring the benefits to the broader population at large. However, the “FAANMG” stocks are in some cases facing greater competition as shown last week by Disney’s results being boosted by the performance of its streaming media service Disney+. The market gave a strong positive response as the stock broke above its pre-crash levels despite what might otherwise have been considered a negative development as Disney reduced its dividend payment to support additional Disney+ investment. Clearly, Netflix understands competitive pressures in the space are intensifying as deeper pocketed players with strong consumer franchises are getting into the game.

More importantly, as mentioned last week, there is still a “growth scare” as Wall Street estimates for 4Q 2020 and 1Q 2021 earnings remain below 3Q 2020 levels, this despite what has been a phenomenal performance during the 3Q 2020 earnings season. The caution is certainly attributable to the market recognizing that the current COVID resurgence is keeping consumers closer to home and the high probability that until the Biden administration takes office in late January 2021 there will not be an effective national strategy to address COVID.

That said, there should still be an allocation to Growth names such as the “FAANMG” for three reasons. First, the “growth scare” implies a slow and possibly halting path to recovery during which the greater earnings certainty of the “FAANMG” should support a premium valuation relative to the S&P 500 index. Second, technology remains the primary driver of disruption that results in either the creation of entire new markets or results in substantial market share shifts within existing markets, something that should be a core portfolio holding. Third, new product cycles are unfolding at both Apple (i.e. iPhone) and Microsoft (i.e. Xbox) that will serve to sustain, if not accelerate, growth. With that in mind, it still makes sense for there to be some degree of profit-taking in a group that has led the broader stock market off its March 2020 lows, especially as COVID vaccine news has brought hope the broader global economy will recover over the course of 2021 and accelerate going into 2022.

With accelerating economic recovery as a stock market backdrop, investors should be looking for sectors and companies that can produce high positive earnings leverage off the expected revenue growth. Such sectors characterized by high fixed costs are Consumer Discretionary, Energy, Industrials and Materials. In this scenario, it also makes sense to increase exposure to small caps that are similarly leveraged. Last week’s breakout move by the Russell 2000 through its January 2020 high confirms the stock market sees the potential in small caps. Meanwhile, with Financials, the yield curve may be capped at the long end as central banks are managing long-term interest rates through quantitative easing.  

Question 2:

David – we have spoken a lot about the return of the consumer, but the soaring coronavirus cases could spur shutdowns that might be less draconian than those earlier this year yet would still hit the economy.  According to J.P. Morgan, consumer spending by the company’s 30 million Chase credit- and debit-card holders has fallen “notably” in its latest data through Nov. 9, down by some -7.4% from the figure a year earlier.   Drops have been larger in states where Covid-19 is spreading most rapidly, but the data suggest a widespread pullback. 

In addition, last Thursday Federal Reserve Chair Jerome Powell commented that while he sees the economy in a solid recovery, “with the virus now spreading, the next few months could be challenging.”   When you consider that it took only two weeks of closures in March to drag down first-quarter GDP by -5% and then it was   the $2.3 trillion Cares Act that helped to produce the stronger-than-expected rebound in the third quarter, at a +33.1% annual rate, does the fact we are now facing a fading chance of a fiscal response to a renewed downturn worry you? 

Rick, call me early, but I have been banging the drum on the need for further fiscal stimulus since July as we view the stock market as being in large part for 2020 a liquidity-driven flywheel requiring steady and rising levels of fiscal stimulus and monetary easing to sustain the economy during the COVID depression. 

Needless to say, Congress was unable to accommodate this need due to increased partisan differences in the run-up to the U.S. elections. Failure to do so has left the economy vulnerable to the as yet unchecked spread of COVID which as noted earlier is resulting in the “growth scare” reflected in Wall Street earnings estimates. 

About the best thing that can be said about Congress now is that the likelihood of a divided Congress is that tax rates will remain unchanged for longer and broad-scale policy programs may be more difficult to implement. 

For now, we unfortunately have one political party more concerned about contesting the recent election results than it is in looking after the health and well-being of its constituents who are suffering severely under COVID. This indifference will likely not be forgotten come the 2022 midterm elections. 

Question 3:

David, it has been some time since we talked about investing outside of the United States, but last week International stocks gained +4% compared with +2.2% for U.S. equities, signaling increased optimism in the longer-term global rebound.  When you consider that in international markets we find…

  • 7 of the 10 largest automobile companies
  • 7 of the 10 largest diversified telecommunications companies
  • 8 of the 10 largest metals and mining companies
  • 6 of the 10 largest electronic equipment and instruments companies
  • 5 of the 10 largest household durables companies

International stock investments provide a diversification benefit relative to an all-U.S. equity allocation and just last week, in an Bloomberg Radio interview,  Brian Levitt from Invesco said “in general, investors are woefully under allocated to markets outside the United States”     

Would you agree and, if so, are there any specific markets you would suggest our listeners consider?  

Rick, it is true that most U.S. investors are underinvested in other markets globally. In this respect, we have highlighted that, among the 11 S&P 500 sectors, Technology has the greatest exposure to non-U.S. markets and as such is an indirect global diversification portfolio allocation. Also, we have discussed previously that the U.S. Dollar has a cyclical tendency to weaken early in economic cycles. To this we add that relative economic growth rates are important as there is now a distinct differentiation taking place in global markets between those countries whose economies are growing as they put in place policy measures to contain COVID successfully and those countries that have failed to do so.

In this regard, Asian markets have outperformed in 2020. For example, the MSCI China index has outpaced the S&P 500 index by +15% so far this year, this despite last week’s drops in names like Alibaba (-13.1%), Meituan (-6.4%) and Tencent (-2.0%) in response to the PRC government moving to rein in its Technology sector by pushing out the Ant Financial IPO. 

More broadly, the MSCI Emerging Markets index (“EM”) was up only +0.8% last week and is lagging the S&P 500 by -3.3% so far this year. We continue to worry that EM is too heavily weighted to Chinese Big Tech and more generally the country’s stock market, although we like this asset class better than MSCI EAFE index (non-US developed economies) which has too little Tech exposure relative to the S&P 500 or Emerging Markets.

For investors who are interested in the greater economic stability in Asia and wish to have Tech exposure, South Korea (ETF ticker EWY) and Taiwan (ETF ticker EWT) markets may offer a better means of gaining exposure than taking on the unpredictability of PRC regulation.

Question 4: 

David, as we bring another episode of A Brighter Future to a close today, I want to get your perspective on what is going on in the credit markets.  I know our Investment Committee has for some time been reducing our exposure to the high yield bonds and I recently read a research report that said there are two conflicting views in the credit markets.  On one hand, with expectations of a gradual economic recovery coupled with fiscal and monetary stimulus, high-yield credit spreads are expected to tighten from here as trends in defaults slow. 

On the other hand, as a result of historically high debt issuance in recent months, many balance sheets are even more leveraged than they were before COVID-19, and concerns are mounting about if companies in troubled sectors will be able to “earn” their way out an eventual default.

With the Fed backstopping fallen angels, it is no wonder those names have rallied similar to what happened during the 2008 Great Financial Crisis.  However, unlike a decade ago, distressed names are missing out so far, which begs the question: are the high-yield credit markets as healthy as the current spreads indicate? 

So, David, is the slow recovery for distressed debt a canary in the (high-yield credit) coal mine? 

Rick, despite facing the short sharp shock of demand destruction from COVID, high-yield credit spreads have continued to narrow after blowing out in March 2020 as lockdowns were implemented. High-yield spreads last week were +462 basis points (bp) over Treasuries, and as noted have been steadily tightening back to the +403bp seen at the end of January 2020. 

To our view, this progression reflects successful positioning by the Federal Reserve as to its ability to intervene if needed and a sign that investors accept the idea that 2021 will see better corporate cash flows across the credit spectrum. Separately, as high-yield spreads and small-cap stock performance are highly correlated, investors should understand this is supportive of the current strength in the Russell 2000 index. As has been said by others, the market’s muscle is now in the Russell.