3/21/21
S&P 500: 3913
Nasdaq: 13215
10 year Treasury: 1.7%
David R. Snyder, CFA
Despite the dramatic outperformance of value over growth over the last six months, many investors and strategists still are not convinced this trade has legs. According to a Barron’s article this weekend only 52% of 220 fund managers surveyed by Bank of America (BAC 38) believe value will outperform this year. Yet the prevailing opinion on Wall Street is that value is a crowded trade. Just not true as the BAC survey reveals. Growth has been so strong for so long that it will take some more time for investors to give up on growth. Many are still buying the dip.
Value has only made up about half of the underperformance since 2016 and even less going back 10 years. Yes there will likely be short term periods where growth outperforms going forward, but it won’t last. Historically the first six months of mean reversion for value after an extreme underperformance are usually the strongest, but there is still significant outperformance for value after that period.
It is amusing to hear some of the talking heads now advise investors to have diversified portfolios. All last summer these same pundits were focused on growth and Covid beneficiary stocks and rarely mentioned anything about keeping a diversified portfolio. They obviously missed the transition to value and small cap and are stuffed with growth stocks in their portfolios. So now they try to defend their position by telling everyone to keep a diversified portfolio! As if that was their advice all along.
Value outperformance has been positively correlated to some degree to the steepness of the yield curve on US bonds in the past and even more so in this cycle. Although the slope of the yield curve has risen significantly over the past six months, it is still only about 60% of the historical maximum steepening after a recession. Thus there is still room for further steepening of the yield curve as a catalyst for continued outperformance of value stocks.
It is important to understand that interest rates can rise without a sharp increase in inflation because real yields are low. In the past real yields rise coming out of a recession rise even though inflation rates usually decline for the first year. That is because investors are anticipating higher inflation sometime in the future.
Scott Minerd of Guggenheim Investments believes that any inflation spike will be short lived and longer term Treasury yields will go below 0%. He cites 1983 when 10 year Treasury yields spiked as the economy recovered from the 1981-82 recession but then retreated lower until 1986. The only problem with that analysis is that it occurred during a period of secular decline in interest rates. In contrast, from 1955 through 1980, recoveries from recessions were followed by rising rates until the subsequent recession. For Minerd to be correct we must still be in a secular bull market for US Treasuries. Technically the 10 year Treasury yield needs to rise above 2% to have a chance at ending the secular bull market.
In my last writing I declared with high conviction that the bubble in hypergrowth stocks had popped and it has continued to unwind over the last couple of weeks. Believe me this process still will continue for awhile. Zoom Video (ZM 326) is the poster child for hypergrowth highly valued Covid beneficiary stocks. It has declined about 40% from its high last Fall. Brad Gerstner of Altimeter Capital recently stated that ZM is a good value because its price/sales ratio on 2023 estimated sales is lower today than it was pre-Covid despite the stock more than tripling since then. But that is a weak argument in my opinion. ZM’s sales estimates for 2023 have more than tripled because of the benefit of Covid last year. It now has a much higher sales base. This means that ZM is closer to its terminal value then it was pre-Covid and its growth rate going forward using a discounted cash flow analysis will not be as high. Thus a lower price/sales ratio is now justified. Furthermore a year has passed since Covid resulting in its sales being rolled up one year which naturally lowers the price/sales ratio. That is normal for all growth companies regardless of Covid. Covid just magnified the progression for ZM.
Although I am not overweighting technology, there is one tech stock I recently purchased that has potential for outperformance. I have not owned Intel (INTC 64) since 1999 except for a few quick trades when it was unduly depressed. It has been one of the worst performing semiconductor stocks during that time period. INTC missed out on a lot of the growth trends over the last 22 years as it overly relied on its PC chips as the PC industry growth stalled. They especially missed out on mobile phone chips. The last few years the CEO was more of a numbers cruncher than a tech savy executive.
INTC recently hired Pat Gelsinger as their new CEO, who spent the first 30 years of his career at INTC, including a stint as CTO. He is an Andy Grove disciple who is very knowledgeable about tech and especially INTC. He has already exhibited a strong sense of urgency to return INTC to a leadership position. The good news is that INTC has already shipped the frequently delayed 10 nm SuperFin server chip and expects to ship the new Rocket Lake desktop chip at the end of this month. There is considerable market share to be regained vs. Advanced Micro Devices (AMD 79). But it will take time.
INTC will likely have higher costs than expected in the short term but the stock is so cheap that it will likely be more sensitive to its product portfolio development and strategy. The stock has significantly underperformed its peers since June even though it was somewhat of a beneficiary of Covid due to the resurgence of PC’s for the work from home crowd. But it is trading at a 50% discount to its peers at only 13 times 2021 estimated earnings. This is a real turnaround value play in the tech sector.
As for the overall stock market there is not much upside left. I have been probably the most bullish advisor on the stock market with the highest conviction since the bottom last year. However the risk /reward is no longer favorable. Over the next four or five months there is only about 5% upside for the S&P 500 and a downside risk of 10%. Not happy to see the AAII investment survey show over 40% bulls for four consecutive weeks.
Full Disclosure: I own several of the securities mentioned positively. None have been purchased within the last month. The opinions merely represent the opinion of the author as CIO of Journey 1 Advisors, LLC and intended to inform the readers about our investment philosophy and strategy. The contents of this report are based on sources believed to be reliable. It is not intended for circulation. It is not intended to offer investment advice, or to recommend the purchase or sale of any securities or investment product. Investment advice is only given after a client has signed an investment advisory agreement with Journey 1 Advisors, LLC and will be subject to the terms and conditions therein. Your decision to buy or sell a security should be based upon your personal investment objectives and should be made only after evaluating the stock’s expected performance and risk.