Sectors
Our macro view assumes a lower US dollar in the New Year. Our sister BCA Foreign Exchange service published a Strategy Report last week exploring a possible 1.50 print on EUR/USD. The bottom panel of the chart shows that China is firing on all cylinders and is pulling all the levers in reflating global growth. Keep in mind that increasing global trade is synonymous with a declining USD. As the supply/circulation of US dollars increases with rising global exports, a virtuous cycle takes root where a lower USD begets increasing trade in a positive feedback loop. This sparked a thought experiment on our end: what are the US equity sectors implications of EUR/USD at 1.50? First, deep cyclical and high operating leverage sectors will accelerate their outperformance phase as they are responsible for the lion’s share of SPX foreign sourced revenues. In contrast and in a relative sense, landlocked domestic sectors with little if any international sales will underperform in a steeply declining USD backdrop. Taken together our cyclicals over defensives portfolio bent will catch on fire (middle panel). Bottom Line: Rising prospects of a virtuous cycle where the revival in global trade pushes the US dollar lower and ignites a positive feedback loop will further boost deep cyclical sectors at the expense of defensives.
Dear Client, As is custom every year, next Monday November 30 instead of our regular Strategy Report you will receive BCA’s flagship publication “The Bank Credit Analyst” detailing the house views and themes for next year. Our regular publishing schedule resumes on December 7 with our 2021 High-Conviction Calls Strategy Report. On December 14 we will host a Webcast to discuss our calls in more detail and answer questions. Happy Thanksgiving. Kind Regards, Anastasios Highlights Portfolio Strategy A firming demand backdrop for lodging services courtesy of the positive vaccine news, enticing industry operating metrics along with compelling valuations encourage us to take a punt on the niche S&P hotels, resorts & cruise line index. In marked contrast, we recommend investors avoid the high-flying S&P homebuilding index. Home-related survey data paint a rosy picture for homebuilding demand in the coming months underpinned by low mortgage rates and low housing supply. Nevertheless, most of the good news is baked in resurgent homebuilder stock prices and the prospects of rising interest rates, a looming profit margin squeeze and extremely high earnings expectations warn that the time is ripe to shed S&P homebuilding exposure. Recent Changes Upgrade the S&P hotels, resorts & cruise lines index to overweight, today. Downgrade the S&P homebuilding index to underweight, today. Feature Similar to two Mondays ago, the SPX opened weekly trading with gusto courtesy of MRNA’s 94% efficacy vaccine news, but failed to breach previous all-time highs. The market has rallied roughly 10% this month, and while we remain cyclically and structurally bullish, a short-term consolidation period is likely in the cards. Extremely easy financial conditions along with a near halving in implied volatility – which have been key rally drivers since the March lows as we pointed out numerous times in our research – are nearly perfectly priced in the SPX. The implication is that were a meaningful rally to resume, further easing is required which is a tall order (top panel, Chart 1). Another factor underpinning the market’s recent advance is the drop in the CBOE’s implied correlation index (pair wise correlation of S&P500 constituents, shown inverted, bottom panel, Chart 1). However, correlations have collapsed and are near levels that have marked prior temporary peaks in the SPX. Beyond near-term jitters, output is poised to recover smartly next year and most importantly so are SPX EPS. In a recent Special Report we lifted our EPS target to $168 for calendar 2021 and introduced an end-2021 SPX target of 4,000. The GS Current Activity Indicator corroborates our macro four-factor profit growth estimate and heralds a slingshot EPS recovery next year (Chart 2). Chart 1Good News Is Priced In Chart 2One More V-Shape Is Coming Turning over to capital spending, the latest GDP report was revealing. On the surface private sector capex made a splash with non-residential investment contributing 2.88% to real GDP growth, the highest since Q4/1983 when the economy was recovering from that severe double-dip recession. In absolute terms, the Q/Q annualized growth clocked in at over 20%, a growth rate last seen in the late-1990s (Chart 3). Drilling deeper into capex is instructive. Technology investment was on fire. Surprisingly, software took the back seat and investment in tech goods roared. In other words, this data confirms that businesses and consumers alike prepared to work from home and bought up tech gadgets en masse, and stole demand from the future (Chart 3). Looking ahead we expect a reversal of this trend with software retaking the reigns and the rest of the tech sector fading. As a reminder, while base effects really augmented this capex rebound, recovering animal spirits signal that a capex upcycle is in the offing. We have shown in the past that as profits grow, CEOs become more confident in the longevity of the cycle and choose to deploy long-term oriented capital, albeit with a one-year lag. Eventually, this creates a virtuous upcycle where rising profits lead to rising capital outlays that further boost sales and profits and sustain the positive feedback loop (Chart 4). Chart 3Exploring Investment Data Chart 4Lagging Capex Will Also Recover This week we make two sub-surface consumer discretionary sector changes further adding exposure to our back-to-work reopening laggards and shedding exposure to work-from-home winners. Open For Business While admittedly we were early in locking in gains in the S&P hotels, resorts & cruises index last spring by lifting exposure to neutral from underweight, today we are compelled to augment this niche leisure index to an overweight stance. Relative share prices have bounced at a level last seen during the GFC and not far off the level hit post the 9/11 accelerated recession that dealt a big blow to everything travel related (top panel, Chart 5). The recent positive vaccine news is a key reason we are warming up to this consumer discretionary sub group. While neither lodging nor cruise line vacationing will return to their previous peaks any time soon, both industries will survive and thus should no longer be priced for bankruptcy. Industry pricing power has plunged, but it is trying to trough at an extremely depressed level (middle panel, Chart 5). As a result, profit margins have gone haywire (bottom panel, Chart 5), but again most of the negative news is likely priced into this negative profits backdrop. Chart 5Fell Off A Cliff… One key industry demand determinant is confidence. Consumer sentiment has staged a W-shaped recovery and while still flimsy the brightening vaccine efficacy news should catapult it higher in the coming quarters. The implication is that the wide gulf between consumer confidence and relative share prices will narrow via a catch up phase in the latter (top panel, Chart 6). Closely linked to the budding recovery in confidence are discretionary versus non-discretionary retail sales. Thus, the latter have been tightly correlated with the oscillations in relative share prices, and the current message is positive (top panel, Chart 7). Chart 6...But There Are Signs Of Life Moreover, the ISM non-manufacturing survey is on a sling shot recovery following the depths of the spring readings. This rebound also suggests that the path of least resistance is higher for lodging stocks (middle panel, Chart 6). Chart 7Enticing Signals On the business side, capex intentions are slated to increase in the coming year – as we highlighted above on the back of recovering animal spirits – and by extension so will business-related travel (bottom panel, Chart 7). Our hotel demand indicator does an excellent job at encapsulating all these different forces and forecasts an enticing lodging services demand backdrop into 2021 (bottom panel, Chart 6). Already, consumer outlays on hotels are staging a comeback albeit from an extremely depressed level. The upshot is that an earnings-led rebound is in the cards (middle panel, Chart 7). With regards to industry operating metrics, industry executives have reined in expansion plans: construction spending on hotels has been contracting all year long. At the margin, such a supply restraint on the heels of a seven-year expansion phase is quite encouraging (middle panel, Chart 8) as it will aid in the industry’s efforts to lift beaten down occupancy rates. Another reassuring industry operating metric is the confirmation that hotel workers are returning to work. Not only has leisure and hospitality employment absorbed more than half the losses suffered since the spring carnage, but also industry hours worked have ticked higher of late (bottom panel, Chart 8). Finally, washed out technicals and extremely alluring valuations provide an attractive reward/risk tradeoff at the current juncture (Chart 9). Chart 8Receding Supply Is Good Chart 9Plenty Of Upside Netting it all out, a firming demand backdrop for lodging services courtesy of the positive vaccine news, enticing industry operating metrics along with compelling valuations encourage us to take a punt on the niche S&P hotels, resorts & cruise line index. Bottom Line: Upgrade the S&P hotels, resorts & cruise lines index to overweight, today. The ticker symbols for the stocks in this index are: BLBG: S5HOTL – MAR, HLT, CCL, RCL, NCLH. Contrarian Housing Call Today we recommend a downgrade in the S&P homebuilding index to underweight. Since the March 23 SPX lows, consumer discretionary stocks are up 74%, besting the S&P 500 by 1500 basis points (bps). While single stock GICS4 sub-groups like household appliances (i.e. Whirlpool) have reached escape velocity rising over 200% over the same time frame, the S&P homebuilding index is also up a whopping 140%. While we were quick enough to close our underweight recommendation in March and cement impressive relative gains for the portfolio to the tune of 50%, we refrained from lifting exposure all the way to overweight and remained at benchmark. As a reminder, we opted instead to play a housing rebound via the sister home improvement retail index in mid-April that also added significant alpha to our portfolio. Residential real estate optimism abounds. The media’s bombardment is non-stop reminding consumers of runaway home prices, all-time lows in fixed mortgage rates (third panel, Chart 10) and nearly non-existent housing inventory (supply of homes shown inverted, middle panel, Chart 11), painting an urgency to stampede into home buying (top panel, Chart 11). Chart 10Positives Reflected In Prices Chart 11The Good… True, the COVID-19 recession has acted as an accelerant to the suburban housing boom and there is an element of at least a semi-permanent shift away from city centers and toward the suburbs as the work-from-home flexibility is not a fad. Tack on all-time highs on the overall NAHB housing sentiment survey and a number of sub-components like sales expectations (second panel, Chart 10) and no wonder mortgage applications to purchase a new home are also flirting with multi-year highs (bottom panel, Chart 10). Another survey, part of the Conference Board’s consumer confidence monthly survey, revealed that consumers’ plans to buy a new home are also probing all-time highs (second panel, Chart 10). Even the Fed’s October Senior Loan Officer survey highlighted that demand for residential mortgage loans is on the mend (bottom panel, Chart 11). However, we deem that most, if not all, of the good news is already priced in galloping homebuilders stock prices and exuberant expectations. While being contrarian is fraught with danger, as more often than not the herd is right, there is a key macro driver that gives us confidence to our going against the grain housing trade: interest rates. If our economic reopening thesis proves accurate next year, then the COVID-19 winners – homebuilders included – will take the back seat. Importantly, as the economy rebounds and is ready to stand on its own two feet, then the selloff in the bond market should gain significant steam. Using our 100-125bps rule of thumb to gauge how much monetary tightening the economy can withstand in a year’s time, then the 10-year US Treasury yield can hit 1.5% by next March. Historically, interest rates and relative share prices have been inversely correlated and a steep selloff in the bond market is bad news for homebuilding stocks (top panel, Chart 12). Chart 12...The Bad... Chart 13...And The Ugly Meanwhile on the operating housing front, some cracks are forming. New home sales, while brisk in absolute terms, are losing out to existing housing sales and homebuilders have resorted to price concessions in order to drive volumes (second, third & bottom panels, Chart 12). Profit margins are at the highest mark since the subprime crisis and are vulnerable to a squeeze not only from lower selling prices, but also from rising input costs. Framing lumber comprises roughly 15% of a new home’s commodity related costs and lumber prices have been expanding all year long (Chart 13). Finally, unfettered sell-side optimism reigns supreme. Net earnings revisions cannot go any higher as they hit a wall at the 100% ceiling. One year forward relative profit growth expectations are literally through the roof, and even five-year relative EPS growth estimates are up 1500bps since the 2019 nadir (Chart 14). All these metrics represent a high bar for homebuilders to surpass and we would lean against such extreme enthusiasm toward this niche early-cyclical group. However, there is a key risk to our bearish homebuilders call we are monitoring: cheap valuations. On relative forward P/E, trailing P/S and EV / EBITDA bases, home construction stocks offer compelling value (bottom panel, Chart 14). Whether this is a value opportunity or a trap, the jury is still out. For the time being we side with the latter. Chart 14Peak Sell-Side Euphoria In sum, home-related survey data paint a rosy picture for homebuilding demand in the coming months underpinned by low mortgage rates and low housing supply. Nevertheless, most of the good news is baked in resurgent homebuilder stock prices and the prospects of rising interest rates, a looming profit margin squeeze and extremely high earnings expectations warn that the time is ripe to shed S&P homebuilding exposure. Bottom Line: Trim the S&P homebuilding index to underweight, today. The ticker symbols for the stocks in this index are: BLBG: S5HOME – LEN, PHM, DHI, NVR. Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com Current Recommendations Current Trades Strategic (10-Year) Trade Recommendations Size And Style Views October 26, 2020 Favor small over large caps July 27, 2020 Overweight cyclicals over defensives June 11, 2018 Long the BCA Millennial basket The ticker symbols are: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, TSLA, V). January 22, 2018 Favor value over growth
Today we update our Millennial Basket as TSLA and UBER have gone vertical this month rising 29% and 46%, respectively. Specifically, we rebalance the basket back to an equal weight with AAPL, UBER, LEN, and TSLA being rebalanced lower, and AMZN, HD, MSFT, NFLX, SPOT, and V higher. Our Millennial Basket is up 116% in absolute terms and 68% relative to the SPX since inception in our June 11, 2018 Special Report. In addition, we also recommended investors overweight our Millennial Basket on a secular ten year view basis, predicated upon our Millennials spending theme. While profit potential has not changed, recent news and price action in TSLA (eerily reminiscent of the YHOO inclusion in the SPX announcement 21 years ago on November 30th 1999!) compel us to rebalance this basket back to equal weight. We also add another layer of risk management in order to protect cyclical-only profits and institute a rather wide rolling 18% stop. Bottom Line: We reiterate our structural and cyclical overweight stance on our Millennial Basket, but today we recommend an 18% rolling stop in order to protect cyclical-only profits. The ticker symbols in the US Equity Strategy Millennials Basket are: AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, TSLA, and V.
This week we removed the S&P insurance index from our underweight list capitalizing gains of 38% since inception. The underweight served its hedging purpose and softened the blow from our previous exposure to banks. Importantly, the macro environment is also set to improve according to our insurance indicator; thus it no longer pays to be underweight this financials sector sub-group (second panel). Simultaneously, we are reluctant to swing all the way to an overweight stance. Insurance CEOs have been anything but disciplined. Headcount is surging and industry wages are also accelerating. While executives may be preparing for a durable rebound in the coming months, a spiking wage bill will eat into insurance margins (third & bottom panels). Bottom Line: We upgraded the S&P insurance index to neutral from previously underweight locking in gains of 38% since inception. For more details, please refer to this Monday’s Weekly Report. The ticker symbols for the stocks in the S&P insurance index are: BLBG: S5INSU - AIG, CB, MET, MMC, PRU, TRV, AFL, AON, ALL, PGR, WLTW, HIG, PFG, L, CINF, LNC, AJG, UNM, AIZ, RE, GL, WRB.
Since late summer we have published a number of reports arguing for a rotation out of expensive tech titan stocks and into beaten down late-cyclicals. Taking a closer look at the Nasdaq 100/S&P energy ratio is instructive. In just 7 trading days, the share price ratio has collapsed 20% from its November 6th high, once again highlighting the violent ongoing rotation within the US equity universe. Vaccine announcements were undoubtedly the catalyst that accentuated this rotation, but once the news of what appears to be peaking US COVID-19 cases hit the wire, this healthy rotation will likely reaccelerate (see chart). Bottom Line: We continue to recommend investors remain exposed to the economic reopening trade that news of effective vaccines has brought to the forefront.
Similar to last Monday, the SPX opened weekly trading with gusto courtesy of the MRNA’s 94% efficacy vaccine news, but failed to breach previous all-time highs. In the short-term there are high odds that the SPX will move sideways, before rallying higher, in order to digest the recent up move and work off overbought conditions. According to the American Association of Individual investors (AAII), bulls are back in droves and the AAII bull/bear ratio has slingshot to the highest level since January 2018. This is cause for near-term concern as it has historically served as a reliable contrary signal (Chart 1). The knee-jerk equity market reaction on the back of the positive vaccine news has also pushed the percentage of SPX stocks trading above their 200-day moving average to a zenith, warning that the SPX will most likely move laterally (Chart 2). Chart 1 Chart 2 Bottom Line: We remain cyclically and structurally bullish, but in the shorter-term, chances are that the SPX will take a breather. For more details, please refer to this Monday’s Weekly Report.
Highlights Portfolio Strategy The hardening insurance market on the back of firming demand for insurance services especially in residential real estate and automobile markets compel us to lift insurers to a benchmark allocation. A resurgent stock-to-bond ratio, the reopening of the economy and receding fiscal policy, election and COVID-19 uncertainties which will further suppress the equity risk premium, all boost the allure of the S&P asset management & custody bank index. Stay overweight. Recent Changes Upgrade the S&P insurance index to neutral and lock in relative gains of 38%, today. This move also augments the S&P financials sector weighting to a modest overweight stance. Table 1 Feature News of a vaccine last Monday turbocharged equities to new intraday all-time highs, following up from a stellar performance the week of the election as odds of a “Blue Wave” collapsed. One of the implications is that the Trump corporate tax cuts will remain in place and investors breathed a sigh of relief (tax policy uncertainty shown inverted, Chart 1). While a smaller fiscal package owing to a split government postponed the rotation trade, the PFE vaccine efficacy news brought it back with a vengeance. This set up caused equities to discount all the good news in a heartbeat as typically happens when uncertainty is sky high and investors stampede into stocks. As we have argued here a VIX with a 40 handle was overdone and thus we crystalized our gains and closed our long VIX December futures trade prior to the election. We have been preparing our portfolio for such a looming rotation and this has been most evident in our long “Back To Work”/short “Covid-19 Winners” equity baskets. Last Monday they went in polar opposite directions and compelled us to put a trailing stop at the 10% return mark in order to protect profits (top three panels, Chart 2). Chart 1Tax Policy Uncertainty Relief Our recent preference of small caps at the expense of large caps that we first recommended a week before the election also depicts the ongoing equity market rotation out of overvalued tech stocks and into beaten down laggard cyclicals (bottom panel, Chart 2). Importantly, the economic reopening trade is still in the early innings, and we remain cyclically bullish on the prospects of the S&P 500 with a fresh end-2021 target of 4,000 that we updated last Monday in a Special Report before news of a vaccine hit the wires. Nevertheless, the recent parabolic rise in equities raises the obvious question: have stocks run too far too fast? Chart 2“Back To Work” Recovery First, there is no doubt that equities are overextended in the near-term as the collapse in the equity put/call (EPC) ratio highlights. Over the past year, the EPC ratio has formed a clearly defined range and a reading below 0.4 suggests overbought conditions (EPC ratio shown inverted, Chart 3). Second, while the violent rotation has pushed the SPX higher despite the deflating tech sector, we doubt that in the coming weeks the SPX will continue to gallop higher without the heavyweight tech sector partially participating in the rally. As a reminder, adding FANG (FB, AMZN, NFLX & GOOGL) weights to the GICS1 tech sector’s weighting results in a roughly 40% market cap weight of tech-related stocks in the S&P 500 (Chart 4). Chart 3No More Hedging Chart 4Tech Is 40% Of The Market Third, according to the American Association of Individual investors (AAII), bulls are back in droves and the AAII bull/bear ratio has slingshot to the highest level since January 2018. This is cause for near-term concern as it has historically served as a reliable contrary signal (Chart 5). Fourth, the knee-jerk equity market reaction on the back of the positive vaccine news has also pushed the percentage of SPX stocks trading above their 200-day moving average to a zenith, warning that the SPX will most likely move laterally (Chart 6). Chart 5Bull Stampede Chart 6Too Far Too Fast? Finally, following a rough September and choppy October, seasonality is now in favor of owing stocks and given diminishing odds of year-end tax loss selling, equities should grind higher as 2020 draws to a close. Netting it all out, in the short-term our going assumption is that, barring exponential moves in the reopening trade similar to what we witnessed last week, the SPX will likely move sideways in order to digest the recent up move and work off overbought conditions. This is especially true if a selloff in the bond market continues to weigh on the tech sector’s still lofty valuation footprint. This week we make a sub-surface financials sector tweak that pushes this early cyclical sector to a modest above benchmark allocation. Time To Lock In Gains On Insurance The shifting macro landscape signals that it no longer pays to be bearish insurance stocks; thus we are upgrading the S&P insurance index to a neutral weighting today, crystalizing relative gains of 38% since inception. This cyclical underweight exposure in insurance stocks – as part of our barbell portfolio strategy within the financials universe – has cushioned the blow from our positive bank exposure and served its hedging purpose. Now that the election uncertainty is waning and given the recent positive PFE news on the effectiveness of their COVID-19 vaccine, insurance stocks will at least catch a bid. The economic reopening underscores that home and auto sales will continue to climb as nonfarm payrolls make a run for the pre-recession highs likely sometime in 2021. Keep in mind that consumers’ plans to buy a new car and a home are recovering smartly according to the most recent Conference Board survey (third panel, Chart 7). This upbeat demand backdrop for these key insurance end-markets should boost industry profits (bottom panel, Chart 7). Already a hardening insurance market (second panel, Chart 8) owing to pent-up residential real estate and automobile demand is a boon for underwriting results. Chart 7Insuring Gains Chart 8Hardening Market Importantly, the latest national account data corroborates firming final demand for insurance services: consumer outlays on insurance are galloping higher. The upshot is that the insurance valuation de-rating will transition to a rerating phase (bottom panel, Chart 8). Our Insurance Indicator does an excellent job in encapsulating all these moving parts and heralds rosier days ahead for relative share prices (second panel, Chart 9). However, there is a caveat that prevents us from swinging all the way to an overweight stance. Insurance CEOs have been anything but disciplined. Headcount is surging and industry wages are also accelerating. While executives may be preparing for a durable rebound in the coming months, a spiking wage bill will eat into insurance margins (third & bottom panels, Chart 9). Netting it all out, a hardening insurance market on the back of firming demand for insurance services especially in residential real estate and automobile markets compel us to lift insurers to a benchmark allocation. Bottom Line: Upgrade the S&P insurance index to neutral today, cementing relative profits of 38% since inception. This upgrade bumps the broad S&P financials sector to a modest overweight stance. The ticker symbols for the stocks in the S&P insurance index are: BLBG: S5INSU - AIG, CB, MET, MMC, PRU, TRV, AFL, AON, ALL, PGR, WLTW, HIG, PFG, L, CINF, LNC, AJG, UNM, AIZ, RE, GL, WRB. Chart 9One Positive And One Risk Stick With Asset Management & Custody Banks While we have moved to the sidelines on the S&P banks and S&P investment banks & brokers groups, we have maintained bank-related exposure via the S&P asset management & custody banks (AMCB) index and today we reiterate our overweight stance in this early cyclical group. Recent news of industry M&A activity has propped up stocks in this index. Any reduction of supply is great news not only because investors have fewer constituents available to deploy capital to, but also because of oligopolistic power with positive industry pricing power knock-on effects. Tack on the recent selloff in the bond market and factors are falling into place for a durable outperformance phase in the S&P AMCB index (top panel, Chart 10). In fact, the stock-to-bond ratio has caught on fire of late forecasting a pickup in momentum in relative share prices (middle panel, Chart 10). Fund flows are also emitting a bullish signal. Historically, increasing bond and equity fund flows have been positively correlated with the relative share price ratio and the current message is positive (bottom panel, Chart 10). Our view remains that the economy will continue to reopen in 2021 and news of the PFE vaccine reiterates our thesis. Thus, as economic uncertainty lifts, it should lead to multiple expansion in this beaten down early cyclical industry (middle panel, Chart 11). More broadly speaking, receding fiscal and election uncertainties should push down the still high equity risk premium and boost the allure of the S&P AMCB index (bottom panel, Chart 11). Chart 10Increasing Flows Are A Boon Chart 11A Play On The Economic Reopening Securities lending is another source of income for the industry. Oscillating margin debt balances are an excellent demand gauge for such income producing services. Recently, margin debt has made a run for all-time highs in level terms, expanding at a near 20%/annum clip, underscoring that an earnings led advance is in the offing (bottom panel, Chart 12). With regard to earnings, there is broad-based skepticism on the industry’s profit growth recovery prospects both on a cyclical and structural time horizon. The middle panel of Chart 13 highlights that over the past two decades every time sell-side extreme pessimism reigned supreme, it was a good contrary signal. More precisely, when relative 12-month profit growth expectations sink to negative double digits, a reflex rebound typically ensues. We doubt this time will prove different. Chart 12Follow The Margin Debt In sum, a resurgent stock-to-bond ratio, the reopening of the economy and receding fiscal and election uncertainties which will further suppress the equity risk premium, all boost the allure of the S&P AMCB index. Chart 13Lean Against Extreme Analyst Pessimism Bottom Line: We continue to recommend an above benchmark allocation in the S&P AMCB index. The ticker symbols for the stocks in this index are: BLBG: S5AMGT – BK, BLK, STT, AMP, NTRS, TROW, BEN, IVZ. Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com Current Recommendations Current Trades Strategic (10-Year) Trade Recommendations Size And Style Views October 26, 2020 Favor small over large caps July 27, 2020 Overweight cyclicals over defensives June 11, 2018 Long the BCA Millennial basket The ticker symbols are: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, TSLA, V). January 22, 2018 Favor value over growth
The market has rallied roughly 10% this month, and while we remain cyclically and structurally bullish, a short-term consolidation period is likely in the cards. As Chart 1 highlights below, extremely easy financial conditions along with a near halving in implied volatility – which have been key rally drivers since the March lows as we pointed out numerous times in our research – are nearly perfectly priced in the SPX. The implication is that if a meaningful rally is to resume, further easing is required. Another factor underpinning the market’s recent advance is the drop in the CBOE’s implied correlation index (pair wise correlation of S&P500 constituents, shown inverted, Chart 2). However, correlations have collapsed and are near levels that have marked prior temporary peaks in the SPX. Bottom Line: A short-term consolidation phase is likely in the cards
The vaccine announcement this week accelerated the unwinding of the long tech short everything else pandemic trade. While such a rotation is augmenting our portfolio via an explicit long “Back To Work”/short “COVID-19 Winners” trade, as we highlighted in yesterday’s Daily US Sector Insight, our small cap size bias is another prime beneficiary. Specifically, small caps outshined large caps by nearly 4% this week. One of the key drivers behind such a quick move is the delta in sector composition between the small and large cap indexes. The relative gap in deep cyclicals alone is 13% as we highlighted in recent research. The implication is that as manufacturing rebounds, so will the relative performance of small caps (top panel). Moreover, easy fiscal policy is a tonic to the small/large share price ratio. As a flood of money enters the economy with a slight lag, small caps will continue to make up ground lost during the early stages of the pandemic (fiscal balance shown inverted, bottom panel). Bottom Line: We reiterate our recent small cap bias.
Yesterday’s vaccine news reawakened investors to the reality that the world might be going back to normality much sooner than previously anticipated unleashing a violent equity rotation. Perhaps one of the most illustrative examples is the one-day percentage change in our “Back To Work” and “COVID-19 Winners” baskets. The top and middle panels of the chart on the right highlight the point: 7/14 stocks in the “Back To Work” basket experienced more than a 10% increase with AXP leading the pack with a mighty 21% rise. On the other side, pandemic beneficiaries got clobbered with ZM losing 17% of its value. As a reminder, we have been recommending being long our “Back To Work” basket at the expense of the “COVID-19 Winners” basket since early September, and this trade is currently up 15% since inception. Importantly, the economic normalization process has just begun and according to the ISM manufacturing PMI new orders sub-category there is likely a long runway ahead for this pair trade (bottom panel). Bottom Line: Stick with the long “Back To Work” basket / short “COVID-19 Winners” basket, but recent market action is enticing us to put a trailing stop at the 10% return mark in order to protect profits.