Positioning For A Strong 2021 And Better Times Ahead

By some measures, the month of November was the best month for global stock markets in over 20 years, and the rally has carried on into December. Here in the US, the S&P 500 (SPY) gained +12.2% since the end of October through Friday’s close, while the SPDR S&P 400 MidCap (MDY) rose +18.1% and the SPDR S&P 600 SmallCap (SLY) +24.3%. In fact, November was the biggest month ever for small caps. Notably, the Dow broke through the magic 30,000 level with conviction and is now testing it as support. But more importantly in my view, we have seen a significant and sustained risk-on market rotation in what some have termed the “reopening trade,” led by small caps, the value factor, and cyclical sectors. Moreover, equal-weight indexes have outperformed over the same timeframe (10/30/20-12/11/20), illustrating improving market breadth. For example, the Invesco S&P 500 Equal Weight (RSP) was up +16.9% and the Invesco S&P 600 SmallCap Equal Weight (EWSC) an impressive +29.5%.

As the populace says good riddance to 2020, it is evident that emergency approval of COVID-19 vaccines (which were developed incredibly fast through Operation Warp Speed) and an end to a rancorous election cycle that seems to have resulted in a divided federal government (i.e., gridlocked, which markets historically seem to like) has goosed optimism about the economy and reignited “animal spirits” – as has President-elect Biden’s plan to nominate the ultra-dovish former Federal Reserve Chairperson Janet Yellen for Treasury Secretary. Interestingly, according to the WSJ, the combination of a Democratic president, Republican Senate, and Democratic House has not occurred since 1886 (we will know if it sticks after the Georgia runoff). Nevertheless, if anyone thinks our government might soon come to its collective senses regarding the short-term benefits but long-term damage of ZIRP, QE, and Modern Monetary Theory, they should think again. The only glitch right now is the impasse in Congress about the details inside the next stimulus package. And there is one more significant boost that investors expect from Biden, and that is a reduction in the tariffs and trade conflict with China that wreaked so much havoc on investor sentiment towards small caps, value, and cyclicals. I talk more about that below.

Going forward, absent another exogenous shock, I think the reopening trade is sustainable and the historic imbalances in Value/Growth and Small/Large performance ratios will continue to gradually revert and market leadership broadens, which is good for the long-term health of the market. The reined-in economy with its pent-up demand is ready to bust the gates, bolstered by virtually unlimited global liquidity and massive pro-cyclical fiscal and monetary stimulus here at home (with no end in sight), as well as low-interest rates (aided by the Fed’s de facto yield curve control), low tax rates, rising inflation (but likely below central bank targets), and the innovation, disruption, and productivity gains of rapidly advancing technologies. And although the major cap-weighted indexes (led by mega-cap Tech names) have already largely priced this in, there is reason to believe that earnings estimates are on the low side for 2021 and stocks have more room to run to the upside. Moreover, I expect active selection, strategic beta ETFs, and equal weighting will outperform.

On that note, Sabrient has been pitching to some prominent ETF issuers a variety of rules-based, strategic-beta indexes based on various combinations of our seven core quantitative models, along with compelling backtest simulations. If you would like more information, please feel free to send me an email.

As a reminder, we enhanced our growth-at-a-reasonable-price (aka GARP) quantitative model just about 12 months ago (starting with the December 2019 Baker’s Dozen), and so our newer Baker’s Dozen portfolios reflect a better balance between secular and cyclical growth and across large/mid/small market caps, with markedly improved performance relative to the benchmark S&P 500, even with this year’s continued market bifurcation between Growth/Value factors and Large/Small caps. But at the same time, they are also positioned for increased market breadth as well as an ongoing rotation to value, cyclicals, and small caps. So, in my humble opinion, this provides solid justification for an investor to take a fresh look at Sabrient’s portfolios today.

In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals-based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our outlook is bullish (although not without bouts of volatility), the sector rankings reflect a moderately bullish bias (as the corporate outlook is gaining visibility), the technical picture looks solid, and our sector rotation model is in a bullish posture. In other words, we believe “the stars are aligned” for additional upside in the US stock market – as well as in emerging markets and alternatives (including hard assets, gold, and cryptocurrencies).

Commentary:

Given their greater access to capital and wider business “moats,” most large companies have survived (and often thrived) in this tumultuous year – with the notable exceptions of the Energy sector and some Consumer Services industries (primarily related to travel, dining, and entertainment). But more recently, Energy has been showing leadership. In fact, for November, Energy was the clear leader (+28%), and remarkably, since its intraday low on 10/29/20 through Friday 12/11/10 (just six short weeks), the Energy Select Sector SPDR (XLE) is up a whopping +52%. According to S&P Dow Jones Indices, the best performing factor strategies in November were High Beta and Enhanced Value, while Growth and Momentum underperformed. Also, equal-weight indexes have been outperforming their market-cap-weighted brethren.

Although small businesses generally took it on the chin due to the shutdowns, the iShares Russell 2000 (IWM) has been rapidly gaining traction and has now surpassed the YTD performance of the SPDR S&P 500 (SPY), +16.1% versus +15.4%. This is all quite healthy behavior. Moreover, ETFGI reported that assets invested in ETFs and ETPs listed globally reached a record $7.62 trillion, and net inflows hit a record $670.57 billion at the end of November.

Despite its impressive gain over the past six weeks, Energy is still the worst-performing sector YTD, while the top performer is still Information Technology, buoyed by a combination of unstoppable secular growth trends and solutions to pandemic-driven disruption. Recall that during the dawning of the Internet age in the mid-1990s coupled with the runup to Y2K (and fear of widespread computer failure from the 2-digit date turning over zeros), the economy saw a massive capital upgrade cycle in a short amount of time that pushed many technology companies to dizzying heights. Of course, despite the Internet Bubble bursting many marginal companies out of existence, consumers and businesses embraced the Internet and other disruptive technologies – and never looked back. Similarly, today we have seen another “step-function” technological transformation in the economy, this time thanks to the pandemic hurrying the adoption of digitization and tools for remote working, learning, shopping, touchless transactions, gaming & entertainment, disease testing, and precision medicine. Witness the incredible price moves in firms like Zoom Video (ZM), Square (SQ), MercadoLibre (MELI), Pinterest (PINS), NVIDIA (NVDA), DocuSign (DOCU), The Trade Desk (TTD), Beam Therapeutics (BEAM), Quidel (QDEL), and Moderna (MRNA), just to name a few.

I mentioned at the top that stocks have been reacting at least partly to an expectation that a Biden Administration will likely try to “normalize” relations with China by reducing or removing tariffs and other trade barriers. Although I support President Trump’s goals in confronting China and its unapologetic flouting of WTO trade rules and IP protections (after all, someone had to do it eventually, and Trump had the right personality for the job), there is little doubt that, while good for the US dollar (as a global safe haven), it severely impacted corporate visibility, supply chains, investor psyche, and indeed most value- and cyclicals-oriented portfolios like Sabrient’s.

Value/Growth divergence update:

If we look back over the past couple of years since mid-2018 when the trade war escalated, the market’s strength has been somewhat deceiving in that the growth-oriented, cap-weighted indexes have been in a strong bull market thanks primarily to a handful of mega-cap Technology names, while most of the rest of the broader market essentially has been in a downtrend, making it difficult for valuation-oriented portfolios or equal-weight indexes to keep up. To illustrate, below is a 5-year chart (starting 7/1/15) comparing the S&P 500 LargeCap Pure Growth ETF (RPG) and the S&P 600 SmallCap Pure Value ETF (RZV). This chart illustrates the stark market bifurcation and relative performance gaps between large vs. small, growth vs. value, and secular-growth vs. cyclical-growth. (Note: Highly cyclical and value-oriented sectors would include Financials, Industrials, Materials, and Energy.)

Value vs Growth 5-year chart

You can see that after the 2016 election, market breadth and the value factor got a strong but short-lived boost during the “Trump Bump,” and then in mid-2018 the trade war with China launched a stark and historic market bifurcation due more to uncertainty rather than a significant cut to earnings expectations. And the bifurcation has only gotten worse this year due to COVID-19, lockdowns, civil unrest, and a tumultuous election. I have highlighted this dynamic on the chart with the trendlines tracing the higher-highs uptrend in RPG versus the lower-highs downtrend in RZV since mid-2018. The major market-cap-weighted indexes continued to hit new highs, primarily on the backs of the five mega-cap secular-growth Tech stocks – namely Apple (AAPL), Amazon (AMZN), Microsoft (MSFT), Alphabet (GOOGL), Facebook (FB), aka “FAAAM” – while a large swath of the market has been quite weak. As a result, for the past 2-1/2 years, valuation-oriented portfolios like Sabrient’s underperformed, as did many broad-market equal-weighted indexes.

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Disclosure: At the time of this writing, among the securities mentioned, the author held long positions in SPY, EEM, ZM, SQ, TTD, BEAM, QDEL, gold, bitcoin, and ether.

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