The positive news about COVID-19 vaccines, along with encouraging economic data,1 has put the global economy on a clearer path to recovery. However, the lingering pandemic and the systemic behavioral change it has caused have punctured the equilibrium of societal norms — creating both continued uncertainty and new opportunities.
Although broad global equity markets appear likely to finish the year with gains2 and the S&P 500 Index has posted a 1% gain on 27% of the trading days so far in 2020 (the best percentage for a calendar year since 1938),3 the pandemic continues to create an uncomfortable environment of constant change that, unfortunately, is unlikely to relent when the calendar flips to 2021.
While we are likely embarking on a period of recovery, at the same time, we must adjust to the continued evolution of corporate and consumer behaviors resulting from the pandemic. Therefore, we look to 2021 for a “recov-olution”— a period of transition that will require balancing the cyclical opportunities stemming from an ongoing recovery, alongside longer-term secular positions aimed at capturing the evolutionary impacts COVID-19 will continue to have on our society.
A hopeful recovery, but not an easy one
While the S&P 500 Index has posted the highest percentage of 1% gains in a calendar year since 1938, it has also posted losses of less than -1% on 20% of the trading days so far this year — the most since the Great Financial Crisis.4 And the CBOE VIX Index has spent 190 days above a level of 20, a tally higher than that of the past seven years combined,5 underscoring how the pandemic has created abnormally high levels of volatility.
Unfortunately, a similarly high macro risk regime is likely to persist in 2021 due to the resurgence of COVID-19 cases, which now exceed the first wave in March.6 And while the recent vaccine news from Pfizer and Moderna7 is encouraging, there is a difference between having a vaccine and getting people vaccinated. Currently, if all approvals come in on time, only 25 million people could potentially receive the Pfizer vaccine by year end.8 The logistics of distributing the vaccine also present challenges — particularly delivering it to developing nations.9 Not to mention, only 51% of Americans have indicated that they would take the vaccine.10
This high-risk regime, however, has been supported by significant monetary and fiscal stimulus and has led to positive market gains on the year. Not surprisingly, though, given the questions surrounding the sustainability of firm operations and the likelihood of future growth with so many unknowns facing our society, Quality has been one of the best-performing factors in the US and around the world, posting positive excess returns of 3.7% for the US, 10.4% for developed ex-US, 1.9% for emerging markets, and 9.6% for global universes in 2020.11
The factor landscape changed following the positive vaccine news, however. Value, a more cyclical exposure that has been out of favor for the past decade — as evidenced by it outperforming Growth in just 14% of the 129 rolling five-year periods since the end of 200912 — has had a recent resurgence. Value stocks have rallied 17.7% so far in November, compared with 10.3% for Growth and 9.7% for the broader market.13 This trend of a resurgent value trade, based on the hopes of a recovery, had been building for the past three months. Value has bested Growth on nearly 60% of the trading days in the past three months — well above the full-year rate of 42% for 2020 and the average rate of 47% for the past decade.14
Value’s resurgence is not a complete surprise. To a degree, it follows the conventional playbook in a not-so-conventional time. If growth is expected to broadly improve from a more open economy as a result of a vaccine and the ability to test at home,15 then, all else being equal, investors may seek out the cheaper source of growth. For example, if two stocks are expected to grow earnings by 10%, and one trades at a price-to-earnings multiple of 21 and the other at 13, the latter will likely be chosen when there is more widespread growth — the inverse of when growth is scarce and investors are willing to buy growth at any price.
Yet, just as we likely have experienced a once-in-a-lifetime pandemic, we also expect a once-in-a-lifetime recovery that is difficult to model with any certainty. With the prospects for an uneven recovery, potentially featuring run-ups in Value and questions on the sustainability of earnings growth that may lead to further gains for higher-quality stocks, a portfolio’s core should reflect these two distinct style traits — creating additional balance that allows for more specific “recov-olution” positioning elsewhere for the potential cyclical and secular changes ahead.
Banking on a cyclical recovery
To more directly position for cyclical change in a high-conviction manner, there are a few options from a style and sector perspective. All are value/cyclically oriented, given the premise that if growth is plentiful, then consider favoring the market that offers the cheaper price to access that growth. As shown below, when compartmentalizing the US equity market by cyclicals and non-cyclicals — or even Value versus Growth — we can see how lofty earnings-per-share (EPS) growth is expected to be over the next two years for the cyclical/value components of the market. Given the difference in valuations,16 and with these expectations, it may not be a surprise to see sentiment shift upward as a result of more positive economic and vaccine data.