Rhys Williams, CFA
CIO, Opportunistic All Cap Equity, Spouting Rock Asset Management
We begin June with the 64-million-dollar question, Will restarting the post-COVID-19 US economy while pumping unprecedented amounts from fiscal and monetary stimulus just cause transitory inflation? Or something closer to the wage-price spirals of the post-war years? The truthful answer…. We just don’t know. And since nothing on this scale has been tried before, we respectfully believe that no one else knows either.
In that spirit, we believe constructing a portfolio that hopes for the best but prepares for the worse makes particular sense at this juncture.
Let’s review where we are. This past earnings season was arguably the most ebullient in my 35-year career. Companies didn’t just beat estimates, they obliterated forecasts, which was a combination of a tremendous economy for all things goods and conservative forecasting due to COVID-19 fears. Most Federal Reserves would take this data, combine it with help-wanted ads that border on desperation to find workers, and immediately start taking away the liquidity punch bowl.
Not this Federal Reserve.
Most government leaders of the last 50 years would take this same data and conclude that COVID-19 relief had been a major success and begin to take the pedal off the floor of fiscal stimulus.
Not this Federal Government.
How has the equity market responded in 2021 to these various macro factors? The first six weeks saw growth stocks ascendant as they catapulted higher off of strong year-end results with better outlooks. Once the bond market began to get nervous that news was too good, for the existing very low interest rates, growth stocks sold off simultaneously with rising rates. Growth stocks however, sold off far more than interest rates rose. The S&P 500 Index really didn’t blink as the February to early May period shifted the baton to value stocks, those that directly benefit from a rising economy. The placid Index masked a vicious rotation underneath the hood. By May, interest rates began to peak, at least short-term, and the market started to rotate back toward growth stocks, many of which were off 20% to 40% since February highs.
What can we conclude? There appears to be much more sector risk than market risk. The overall interest rates continue to be so low that declines in the equity market are bought, possibly arguing a large overweight in equity allocation.
But we do think it is prudent to have a barbell portfolio, which should allow for strong performance if growth stocks rebound, but has some value stocks in case inflation and interest rates do rise more than the Federal Reserve currently believes.
One factor that really hasn’t had its day in the sun is quality, typically measured by a strong balance sheet and very steady but not spectacular growth. The market rewarded top line growth in the first few months of 2021 and sensitivity to GDP growth after, but quality growth stocks, which tend to be more predictable growers, were left out of any buying stampede. They are now relatively cheap to the market. This has been a market that likes to afflict the comfortable and comfort the afflicted, by a taking down the current leaders, and rotating into what hasn’t worked. Quality has underperformed since last summer, so it may be a factor that shines in the summer of 2021. These kinds of stocks are long term compounders, which tend to make big moves, and then rest for a while. We believe now may be the pause that refreshes.
The views expressed are those of Spouting Rock Asset Management as of June 1, 2021 and are not intended as investment advice or recommendation. For informational purposes only. Investments are subject to market risk, including the loss of principal. Past performance does not guarantee future results. There can be no assurances that any of the trends described will continue or will not reverse. Past events and trends do not imply, predict or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index.