Ah, The Big 10 has decided to play football this season, reversing its decision to cancel all fall sports.  What a relief to football fans all over the country who were having a difficult time imagining an autumn without college football, which represents the heart and soul of campus communities all over the nation.  Like almost everything else, this season won’t be a normal one, with no fans in the stands, no non-conference games, and athletes and coaches living in a protective bubble, whatever that means.

The “Great Virus Crisis,” as noted economist Dr. Ed Yardeni has called it, is still impacting virtually every aspect of our lives.  Nevertheless, every day we get closer to a solution, as research labs around the world are working diligently to discover an effective vaccine.  It’s only a matter of time until science solves this problem. 

In the meantime, the GVC’s impact on the stock market has pretty much run its course.  Unless every potential vaccine currently in clinical trials fails, I don’t envision another significant downturn driven by Covid-19 developments.  In a nutshell, the market has discounted the economic impact.  The speed and magnitude of the recovery is now going to be more of a driving factor for the market.  On that note, the recovery will be far from a smooth one.  Even within industries, the rate at which earnings recover will vary depending on how well companies have adapted to the challenges caused by the pandemic. 

Will the stock market continue to be led by the same familiar names – Facebook, Amazon, Netflix, Google, Tesla, Microsoft, and Apple?  Or will out of favor sectors – Financial, Energy, and Cyclicals drive a reversion to the mean?  The recent performance gap between the aforementioned leading “growth stocks” and the underperforming “value stocks” has never been greater.  Large Cap Growth stocks have appreciated 33% over the past year, while Large Cap Value stocks have actually depreciated over 3%.  Like the eventuality of an effective vaccine, reversion to the mean will happen eventually.  What does this all mean for investors?

It seems reasonable for investors who own substantial positions in these highly successful, leading growth names (FANGTMA) to continue to do so, but it would be a valuable exercise to limit the percentage held in these names in relation to the size of one’s overall portfolio, particularly if they continue to appreciate at the same pace.  One of the most challenging investment decisions to make is when to sell a stock that keeps going up.  Invariably, few investors do this well, primarily because they become too emotionally attached.  A better approach is to set a target price and then manage the position incrementally within predetermined active-bet limits.  In other words, compare the percentage weight of the holding relative to your overall portfolio v the percentage weight of that stock in the benchmark.  In essence, easing into a stock, then easing out of a stock in phases, can be an effective way to remove the emotional attachment which so often prevents prudent investment decision making.

What might cause this “growth” v “value” reversion to the mean?…  As we saw briefly earlier this month, a sharp market correction is often led by the same stocks that led the prior advance.  Most of the FANGTMA names fell more than the market during the pull-back in early September.  An extended market correction, if one occurred, would most likely spur further profit taking in this group, causing these stocks to lead on the downside.

Additionally, should any other geopolitical event cause an economic downturn, value stocks would likely hold up better.  While the Fed is doing all they can to extend the economic recovery, the potential for higher taxes and onerous regulation is always a threat to global economic growth. 

Balance seems warranted… From an equity portfolio perspective, it makes sense to have a balanced approach.  Maintain reasonable exposure to the leading growth names, while steadily and deliberately adding exposure to high quality, out-of-favor value names.  Your investment team is focused on doing exactly that. 

Michael Kayes, CFA

Recommended Posts