Market Shift to Value
There is a shift going on in the markets that I think is going to be beneficial for investors, at least in the short run. We'll examine the shift that is taking place and the underlying economic conditions in this week's Market Musings.
• Valuation Tectonic Shift. For the past four calendar years, Growth has out-performed Value equities by an average of 1700 basis points. This year, Value is out-performing Growth by 870 basis points, so far. Last year was a bit of an anomaly as Tech names became the darling of the work-from-home model as a result of the pandemic. As states are rapidly re-opening, those same Tech names are facing valuation challenges. Meanwhile, interest rates are rising and inflation fears are growing (more on that in a minute), causing investors to look at under-valued names as they shift their asset allocations. We can see this in the weekly asset flows into "value" ETFs versus "growth" ETFs (see graph below). This rotation is likely to continue as institutional funds begin rebalancing procedures at quarter-end to reduce over-valued names while purchasing under-valued names. What happens when Value overtakes Growth? The broad markets are typically lifted higher. The last 3 calendar years that Value led Growth were 2012, 2014, & 2016. In each of those years, Value stocks led Growth stocks by an average of 430 basis points. At the same time, the S&P 500 Index out-performed Growth stocks by an average of 220 basis points. So, when Value does out-perform, it doesn't mean that Growth stocks are going away, but it does mean broad markets are likely to continue moving higher.
We do have a bit of a unique situation this year as we are recovering from a pandemic and states are re-opening. In addition, we have both rising rates and rising inflation, which we haven't seen since 2006. Traditional "value" sectors such as Financials, Energy, and Utilities are not exactly performing as one might expect. Energy (+39.3% YTD) is skyrocketing both on lower supply and increasing demand. Financials (+14.3%) are up also, which one might expect as valuations are changing and interest rates on the rise. Utilities (-1.9%), however, are lagging. We believe that will change as inflation continues to rise - utilities being one of the few staples consumers will not do without. Likewise, on the "growth" side, things are not progressing exactly as expected. Technology (-1.3% YTD) is down as valuations on that sector have been stretched. Healthcare (-0.4%) are lagging both from valuations (positive 4 years in a row) and the uncertainty around the new Biden administration's priorities involving healthcare going forward. But, Consumer Cyclicals (+3.1%) are not down, but rather, are responding to consumers in areas that were formally locked down now having access to spend on discretionary items.
• Improving Economy, But Inflation Is Being Eyed. The economic recovery continues as releases have been on the lighter side this week. The biggest news was what appeared to be a tame inflation report on Wednesday as the Consumer Price Index rose as expected 0.4% for the month of February. The market cheered this report, but if you look at the year-over-year CPI, it increased 1.7%. This number may be a little shaky over the next couple of months as consumers stopped spending during the first couple of months of the pandemic, so March & April's CPI on a year-over-year basis may be deceiving. However, the month-to-month number will be closely watched going forward. The same holds true for the Producer Price Index (sometimes a foreshadow of CPI). This morning the PPI for February was in-line with expectations (+0.5% month-over-month), but the year-over-year number increased 2.8%, slightly higher than the 2.7% expected. Rising inflation is real and the market is keeping a close eye on the situation. The NFIB Small Business Optimism survey showed a slight increase in February among small business owners. Weekly Jobless Claims came in lower than expected this morning. The market was looking for 725k claims and the number for last week was actually 712k. Later today we will get the number of Job Openings for February and tomorrow the Producer Price Index and preliminary Consumer Sentiment (UoM) number, which is expected to improve. Meanwhile, the National Financial Conditions Index continues to be steady week-in and week-out.
• Progress on Re-opening. The virus numbers are very steady and the vaccine rate is continually improving. Earlier this week, the daily Death number fell below 1,000 to 748, which is the first time since November. That number is obviously still too high, but the vaccine distribution to the elderly is making the situation better every day. Now that the J&J vaccine has rolled out, nearly 2.2 million people are receiving vaccine shots on a daily basis. So far, 95.4 million have received at least one dose of the vaccine with nearly 130 million doses having been delivered. More than 28 states are now fully re-opened, yet progress is being made in those states that imposed draconian lockdowns. Michigan is now at 50% capacity on restaurants. Pennsylvania has lifted travel restrictions, but indoor gatherings are still limited to 15%. Maryland is now at 50% restaurant capacity, while New York is at 25% and New Jersey at 35%. Strangely, California, which is at a daily case low of 3,400 (not seen since mid-October) is still under travel restrictions and outdoor dining only.