Opportunities Remain in Stocks’ Splintered Recovery

by | Apr 27, 2020 | Uncategorized | 0 comments

With the economy spiraling into a depression (25% or more unemployment), the S&P 500 stock index’s dramatic 27% recovery from its March 23 low can largely be attributed to:

  1. investors looking beyond the next few quarters of weakness,
  2. investors valuing firms with a long-term view of normalized earnings, and
  3. massive liquidity provided by the government

Despite stocks’ impressive gains, the recovery has been highly splintered by industry sector. As shown in the chart above, the energy (Royal Dutch Shell), financial (US Bancorp), and industrial (Honeywell) sectors remain much more depressed from their February 19 peak than other sectors. In contrast, health care (United Health Group, Novo-Nordisk) and consumer staples (Pepsi, Colgate Palmolive) are nearly back to their previous highs.

Although Consumer Discretionary has moved similarly to the S&P 500 index, that sector contains its own winners and losers. Amazon represents about 40% of the index, offsetting losses from brick and mortar retailers (Nordstrom), travel (Delta), and entertainment firms (Las Vegas Sands) whose valuations remain battered.

What we observe across industry sectors is that investors are favoring stocks that are less sensitive to economic growth. Strong balance sheets are especially important in highly cyclical businesses for times like these.

Historically, the stock market produces some of its best gains as economic conditions improve from terrible to less bad. The recent rally in energy stocks, despite record-low crude oil prices is an example.

The market’s next move is likely to revolve around expectations for reopening the economy and an assessment of losses caused during the closure (bankruptcies). With the incidence of new Covid-19 infections plateauing and mortality rates lower than expected among healthy people under the age of 65, there is good reason for optimism. Because less cyclical stocks are already trading at high valuations, the best gains are likely to come from the most depressed sectors.

0 Comments

Submit a Comment

Your email address will not be published. Required fields are marked *