Corbin Footitt
January 26, 2021
It’s a stock pickers market - January 2021
After a sharp but short bear market in early 2020, the equity market has recovered and then some, which begs the question: “is there still more to come?”
We believe there is, but not necessarily across the broader market. It’s early in the economic recovery, and given the nature of the downturn, there appears to be significant room for the economy to run. That said, a strong economy doesn’t guarantee a strong equity market or vice versa, and we believe there are underappreciated broader market risks due to a concentrated group of overvalued stocks that now dominate the index. In time, this phenomenon should correct itself and fundamentals should lead to normalized values. In the meantime, this has produced one of the best stock picking opportunities in years. For every overvalued stock in the market, there is an equally undervalued opportunity with considerable upside potential.
Recovering Economy Benefits Cyclicals
We believe that the big story for 2021 will be the recovery of the economy in the second half, and the start of a return to normalcy which should carry into 2022. Of course, the COVID-19 vaccine’s effectiveness and deployment are key to the recovery. At this point, we believe these will be successful. Additionally, a host of indicators appear to point to a recovery that could well exceed expectations:
- Depleted inventories impacted by COVID related activity interruptions will need to be restored
- Pent up demand from a strong consumer with significant savings as a result of generous government handouts and reduced spending
- A strong housing market supported by low interest rates and improving demographics as millennials start entering the market
- Extreme accommodation from central banks (monetary) and government support (fiscal)
Political Landscape
With the Georgia run-off election decided, the Democrats have secured a sweep. Given the slim majority, we expect a moderate Biden-led government which should continue to be relatively market friendly.
The setup is strong for risk assets with the prospects of a recovering economy in the second half of 2021 and a “friendly Fed” that is committed to achieving an average inflation target (meaning above-trend inflation will be tolerated).
More specifically, we believe there is an opportunity among unloved cyclical stocks that are both relatively cheap compared to the broader market and provide greater leverage to a recovering economy. The potential for greater fiscal stimulus under Biden could provide further support to cyclicals.
The Fed has hosted a pretty good party so far but as the economy recovers, it will need to pull the punch bowl away and shift from its extremely accommodative policy stance. We’re not saying that will happen today, but it will at some point, and the market will likely figure this out well ahead of the Fed. We continue to caution investors against engaging in speculative concept investing that is disconnected from fundamentals-based valuation metrics.
What’s Next?
Higher priced assets today generally mean lower returns in the future. Likewise, assets that are undervalued have more room to run. Investors have enjoyed strong returns from a number of stocks over the past decade, but the result is some noticeable imbalances that often precede regime shifts.
Complacency and extrapolating prior returns into the future is a dangerous game. Now more than ever, we believe disciplined stock picking is the best strategy to tap considerable upside potential relative to the broader market and to avoid the risk of an unfavorable shift from growth stocks which currently dominate market indexes.
Now the question is: Where do we go from here? There is a difference between a rebound and a recovery. To own many of these heavily impacted stocks, one must look out to the hopeful 2023 analyst estimates to justify where they currently trade. Hope is a terrible investment strategy…But we must acknowledge that unprecedented global Central Banks’ deep involvement has changed the nature of markets from a price discovery of highest capital return function, to a capital raising for liquidity purposes function. Historically, companies or countries that couldn’t cover their interest cost went bankrupt. Today, Central Bank bond buying allows them to continue to refinance or “extend and pretend” Long term investors need to remember that there is a difference between liquidity and solvency.
My belief that the best growth prospects are focused on the re-platforming of technology, the digital transformation of enterprises, new gene editing treatments, combination drug therapies, new medical devices, hasn’t changed. The evidence has been clear for years that we are at the beginning of an unprecedented maelstrom of innovation and disruption that cuts across industries and geographies. While we are hopefully at the beginning of the end of this catastrophic pandemic, the economy that lies ahead will be very different in many ways, and the acceleration of secular and digital transformation in many industries, will not mean revert. – Noah Blackstein, Jan 2021
We’re excited about 2021. It’s still early in the economic recovery and we’re very encouraged by signals that tell us this one has legs. As asset allocators and stock pickers, we’re finding a number of great opportunities to take advantage of for our portfolios.
We are very positive on the outlook for equities, but we caution investors against being complacent about the risks of broader index-based strategies given the market’s over concentration and imbalances. Our continued due-diligence allows us to manage these risks for our clients while also positioning our portfolios to benefit from the considerable upside potential among undervalued stocks.