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Ten weeks on from the market lows in March, we have seen the equity rally broaden out with a rotation towards value at the expense of growth stocks. Cyclicals have outperformed defensives and high short-interest stocks have outpaced crowded and low short-interest stocks.
These moves have been driven by excitement for economies reopening and renewed risk-on appetite. However, this relative change could be short lived as it has not come with a change in the macro narrative – growth is still scarce, and quality is still necessary in a fragile market. Both higher bond yields and improved PMIs could be needed for the cyclical rotation to be sustained.
Despite the recent rotation, investors remain cautious (as illustrated by flows and sentiment indicators). At State Street Global Advisors, we remain wary about the length of economic recovery and high earnings multiples. There could be many corporate disappointments on the path to recovery. The risks are still out there.
For these reasons, we still believe in taking a relatively defensive approach and focusing on sectors that could weather the turbulence of public health measures and economic change. Our recently published article, 5 Sectors to Watch during COVID-19, provided an update on our Q2 SPDR Sector Picks: Health Care, Technology and Communication Services, and also offered commentary on two other defensive sectors, Utilities and Consumer Staples.
The market has moved beyond its total focus on COVID-19, where liquidity and corporate survival were essential elements, and is now considering political risk and longer-term themes. We believe that Health Care and Technology are particularly well positioned for long-term trends, regardless of the path to economic recovery.
Health Care and Technology ETFs have continuously dominated sector ETF inflows during the last three months. Both sectors have offered quality characteristics and, importantly, strong cash flow and dividends in an environment starved of income. Post the Q1 results season, earnings forecasts were reduced, although not as severely as across other sectors, and the growth rates remain well above average this year (see Figure 1). Looking ahead, businesses within these sectors, particularly biotechnology and software, provide key exposure to future trends.
Earnings per share growth in 2020 (%)