Growth focused stock-pickers need to prepare for a coming rotation that will realign opportunities and risks for investors in the second half of 2021 and beyond.
“As 2020 progressed, it became increasingly apparent that the very wide dispersion in performance between the winners and losers was stretched to an unjustified level,” said David Philpotts, head of strategy in the QEP investment team at Schroders.
As a result, the dominant performance in recent years of a narrow group of popular mega-cap stocks in the US and emerging Asia will likely end soon, he explained, amid an emerging rotation spurred by vaccine rollouts.
In line with this, Philpotts identifies 10 potential themes to shape this rotation in the months and years to come.
1. Good news already in the price
Equity markets face a trio of headwinds: high valuations, limited room for interest rates to fall significantly, and high government debt burdens. With many stocks and most major equity indices close to all-time highs, they are more vulnerable to any adverse news flow.
2. Significant opportunity for value to rebound
The arrival of vaccines in November 2020 was also a welcome event for markets – halting excessive dispersions in valuations from a prolonged period with little discrimination between cheap quality stocks with superior fundamentals and those facing cyclical or structural headwinds to business models. Yet the rotation since then represents only a modest reversion in valuation multiples. The re-rating of neglected stocks has much further to run.
3. Expensive growth bubble may deflate
The “winner takes all” investment philosophy of the past decade looks doomed. The extreme valuations of many popular stocks will make it difficult for them to live up to the lofty expectations built into premium valuations.
4. US market at most expensive level for five decades
The US potentially faces the biggest revaluation risk, given the dominance in recent years of a small group of index heavyweights. Opportunities to find value might exist in pharmaceuticals and “old school” technology companies, but the US in general faces strengthening headwinds.
5. Emerging Asia cheaply valued with good growth prospects
While Asia also has a small number of strongly performing mega-cap companies, the region overall is more cheaply valued than developed markets, with growth and value opportunities. Asian emerging markets could perform well in the year ahead, especially export-sensitive areas most geared to global recovery.
6. Higher inflation is a short-term risk
The potential for inflation to overshoot in the short run – as cost-push and demand-pull forces combine – will create a new conundrum for policymakers that could rattle equity (and bond) markets. At the same time, rising inflation has historically been supportive for cyclical sectors – namely, materials, industrials, consumer discretionary and banks.
7. Healthcare sector looks cheap
Opportunities exist in less cyclically exposed areas of the market, such as healthcare – a disparate sector with some parts already hot, such as biotech/genomics. Pharmaceutical stocks look attractively valued, partly due to their defensiveness and partly the risk of impending US drug price regulation.
8. Environmentally focused investing is here to stay
Widespread political commitment to the Paris agreement suggests continued downward pressure on carbon emissions; so companies will need to adapt. The shift towards non-fossil fuels will be a key focus for investment in the next decade, alongside emerging technologies in battery storage and biofuels.
9. Social considerations increasingly important
Heightened awareness from the pandemic of the importance of social issues, such as mental health and rising inequality, is likely to mean companies that are more responsive to their wider impact on society will see increasing benefits to investment performance.
10. Thematic investing and “value indifferent” investors
Investor demand is keeping pace with the growing number of thematic stocks fuelled by the ongoing disruption. While most of the current themes will likely persist, there is an increased risk of new bubbles forming as retail investors, in particular, buy based on popularity rather than on valuation-based approaches. For long-term investors, this is both an opportunity and a threat.
