Home etftrends.com Pardon the Interruption… But the Match We Think You Should Now be...

Pardon the Interruption… But the Match We Think You Should Now be Watching is Taking Place Elsewhere

Advertisement
Digital Marketing & Website Design for ETFs

IT’S NOT ABOUT ‘STOCKS VS. BONDS’ BUT RATHER ABOUT FUTURE STOCK MARKET LEADERSHIP

By Riverfront Investment Group

Blame it on poor eyesight, but I can remember watching an entire half of a pee-wee football game before realizing that I was in the wrong place and the child I was watching was not mine. Hopefully, I am not the only one to make that mistake. I was reminded of this recently, because I think many investors are watching a match that they believe is important but missing a far more important contest that is occurring somewhere else.

Over the last 5-months investors have understandably been focused on the ‘Stocks vs Bonds’ match i.e. ‘Will there be a second wave of COVID-19, and should I get in or out of the stock market?’ While we do not dispute the virus’ importance, we believe that COVID-19’s grip on the stock market may be loosening. From here on, the more important contest, in our view, is not whether stocks go up or down, but rather which stocks are likely to lead in coming quarters.

Content continues below advertisement

COVID-19 may be loosening its grip on the market:

COVID-19 might be a long way from being cured and its impact to the economy will likely be felt for many more months if not years. However, we see at least three reasons that the stock market has been willing to look beyond COVID-19. First, the ‘policy backstop’ has been tested and appears sound, in our view, as the Fed, Congress, and now the President has supported the economy and the market at varying times. Second, advances in medicine – including promising therapeutics, multiple vaccines in clinical trials, and increases in the capacity of our healthcare system – have provided a ‘light at the end of the tunnel’ that seems to be drawing closer each day. Finally, state lawmakers are becoming more familiar with the controls they have at their disposal and have been able to use the throttle (loosening restrictions) and brakes (tightening restrictions) reasonably effectively to keep outbreaks under control. We believe that the net result of these shifts will be a more ‘normal’ stock market that is driven by multiple factors and away from its singular focus on the virus.

The Real Action May be Taking Place Somewhere Else:

The match we think you should now be watching is currently underway somewhere else, in our view. In this match, an upset could be brewing as the ‘contenders’ are finally making headway against the long reigning champions.

By ‘champions’, we are referring to the secular growth stocks that have been winning since the conclusion of the 2008 Financial Crisis. These stocks tend to share a few of the same characteristics: growth-oriented, US-based, and large-cap. The contenders, on the other hand, can best be described as being either value/cyclical, foreign, or small-cap.

’Champions’ vs ‘Contenders’ is like a Race between the Motorboats and the Sailboats

The champions, in our view, are like motorboats. They come in all shapes and sizes but share the common characteristic of having engines that allow them to move under their own power. We could also use the term ‘secular growers’ to describe them. On the other hand, the contenders have no ‘motors’ and are largely dependent on the economic environment for their propulsion, making them more like a sailboat. Strong economic growth creates the ‘winds’ (greater consumption, improving sentiment, increased inflation) that these sailboats harness and move forward at a pace that can often overtake the motorboats around it, in our view. The ‘sailboats’ can best be described as ‘cyclical growers’ for this reason.

Is the Forecast more Favorable to the ‘Motorboats’ or the ‘Sailboats’?

We believe it is still too early to accurately forecast the underlying strength of the economy, especially given the ‘sugar high’ brought on by extraordinary monetary and fiscal stimulus.

The economy does appear to be strengthening, but thus far that strength appears to lack the lasting power that has historically been most impactful to the sailboats. We believe an economy would need to sustain growth at a rate of at least 4% nominal (including inflation), to generate the ‘windspeeds’ necessary for the ‘sailboats’ to begin winning (outperforming) again. Nominal growth matters more for cyclical stocks because pricing power is important to their ability to grow sales. Following the high inflation of the 1970s, nominal growth was generally between 5% and 7% from 1985 to 2006 (see first box, right chart) remaining above 4% (bold-line) except during the two recessions (see shading). Cyclical stocks benefitted tremendously from China’s explosive growth between 2002 and 2007 as the country rapidly upgraded their national infrastructure as they became the world’s manufacturing giant.

Since the 2008-09 recession, nominal growth has been lower, averaging closer to 4% (see second box); we think this ‘low and slow’ environment is the ‘new normal’ (See our 9/3/19 Strategic View: Low and Slow). Post-COVID-19, we expect US economic growth to average 4% or less and thus struggle to generate strong enough sustained winds for the sailboats to achieve lasting success relative to the motorboats. Rather we expect ‘gusts’ of economic strength from time to time.

The Next Sustained Wind may not Blow for Awhile

To get out of the ‘low and slow’ growth environment, we believe one or more significant catalysts are necessary to push nominal GDP above 4% for a sustained period. In the periods where nominal GDP was above 4%, faster growth led to higher levels of inflation and interest rates, which was also good for the sailboats. Higher interest rates can help the financials, while higher inflation can create a catalyst for companies to spend on capital goods.

Longer term, we see two potential candidates that could create the type of economic growth necessary for the ‘sailboats’ to begin winning again. The first is a potential demographic boom brought on by the Millennials as they replace the Baby Boom generation and enter their prime-spending years. In our view, they alone have the potential to dramatically strengthen the economy for a sustained period. A second candidate is the potential for a significant ‘re-shoring’ trend driven by factors such as the deteriorating relationship between the US and China. Such a trend would cause companies to bring their manufacturing facilities back to the US boosting employment in those industries while also potentially pushing up inflation and interest rates.

Conclusion: Rent the Sailboats, Own the Motorboats

Until there is greater evidence of faster economic growth and the tailwinds it generates, we assume that the recent gusts are just that and will be short-lived. Therefore, our strategy is to rent the sailboats while continuing to own the motorboats.

In our portfolios, we have reduced our overweight to the ‘motorboats’ and added to the ‘sailboats’ over the past few quarters as the economy improved. We have done this selectively by choosing what we believe to be the most agile sailboats, those that can operate with very little wind. Examples include infrastructure companies that we think will benefit from increased government spending. We also like select financial companies that have less economically sensitive businesses, in our view, like trading, or derive their revenues from more stable fee-based business lines unaffected by low rates. A third category would be the cyclical consolidators, like the big energy companies, who we believe have strong balance sheets and can take advantage of the light winds by snapping up their troubled competitors. We will likely remain selective until there is greater proof, in our view, that today’s ‘gusts’ have the potential to be long-lasting.

This article was submitted by the team at RiverFront Investment Management, a participant in the ETF Strategist Channel.

Important Disclosure Information

The comments above refer generally to financial markets and not RiverFront portfolios or any related performance. Opinions expressed are current as of the date shown and are subject to change. Past performance is not indicative of future results and diversification does not ensure a profit or protect against loss. All investments carry some level of risk, including loss of principal. An investment cannot be made directly in an index.

Information or data shown or used in this material was received from sources believed to be reliable, but accuracy is not guaranteed.

This report does not provide recipients with information or advice that is sufficient on which to base an investment decision. This report does not take into account the specific investment objectives, financial situation or need of any particular client and may not be suitable for all types of investors. Recipients should consider the contents of this report as a single factor in making an investment decision. Additional fundamental and other analyses would be required to make an investment decision about any individual security identified in this report.

In a rising interest rate environment, the value of fixed-income securities generally declines.

The Nominal Rate of Return is the amount of money generated by an investment before factoring in expenses such as taxes, investment fees and inflation. 

When referring to being “overweight” or “underweight” relative to a market or asset class, RiverFront is referring to our current portfolios’ weightings compared to the composite benchmarks for each portfolio. Asset class weighting discussion refers to our Advantage portfolios. For more information on our other portfolios, please visit www.riverfrontig.com or contact your Financial Advisor.

Small-, mid- and micro-cap companies may be hindered as a result of limited resources or less diverse products or services and have therefore historically been more volatile than the stocks of larger, more established companies.

Investing in foreign companies poses additional risks since political and economic events unique to a country or region may affect those markets and their issuers. In addition to such general international risks, the portfolio may also be exposed to currency fluctuation risks and emerging markets risks as described further below.

Changes in the value of foreign currencies compared to the U.S. dollar may affect (positively or negatively) the value of the portfolio’s investments. Such currency movements may occur separately from, and/or in response to, events that do not otherwise affect the value of the security in the issuer’s home country. Also, the value of the portfolio may be influenced by currency exchange control regulations. The currencies of emerging market countries may experience significant declines against the U.S. dollar, and devaluation may occur subsequent to investments in these currencies by the portfolio.

Foreign investments, especially investments in emerging markets, can be riskier and more volatile than investments in the U.S. and are considered speculative and subject to heightened risks in addition to the general risks of investing in non-U.S. securities. Also, inflation and rapid fluctuations in inflation rates have had, and may continue to have, negative effects on the economies and securities markets of certain emerging market countries.

Stocks represent partial ownership of a corporation. If the corporation does well, its value increases, and investors share in the appreciation. However, if it goes bankrupt, or performs poorly, investors can lose their entire initial investment (i.e., the stock price can go to zero). Bonds represent a loan made by an investor to a corporation or government. As such, the investor gets a guaranteed interest rate for a specific period of time and expects to get their original investment back at the end of that time period, along with the interest earned. Investment risk is repayment of the principal (amount invested). In the event of a bankruptcy or other corporate disruption, bonds are senior to stocks. Investors should be aware of these differences prior to investing.

You cannot invest directly in an index

RiverFront Investment Group, LLC (“RiverFront”), is a registered investment adviser with the Securities and Exchange Commission. Registration as an investment adviser does not imply any level of skill or expertise. Any discussion of specific securities is provided for informational purposes only and should not be deemed as investment advice or a recommendation to buy or sell any individual security mentioned. RiverFront is affiliated with Robert W. Baird & Co. Incorporated (“Baird”), member FINRA/SIPC, from its minority ownership interest in RiverFront. RiverFront is owned primarily by its employees through RiverFront Investment Holding Group, LLC, the holding company for RiverFront. Baird Financial Corporation (BFC) is a minority owner of RiverFront Investment Holding Group, LLC and therefore an indirect owner of RiverFront. BFC is the parent company of Robert W. Baird & Co. Incorporated, a registered broker/dealer and investment adviser.

To review other risks and more information about RiverFront, please visit the website at www.riverfrontig.com and the Form ADV, Part 2A. Copyright ©2020 RiverFront Investment Group. All Rights Reserved. ID 1305159

newETFs.io respects the hard work of others and gives all credit to the remarkable folks at ETFTrends.com. This excerpt/article was pulled from their RSS feed; click here to view the original. Please note that on occasion, the RSS feed will not have the author. When this happens this site defaults the author to "News". Make no mistake, this excerpt/article was not created by newETFs.io, it was simply shared with you.