Make Way for New Market Leadership

Aside from the recent sell-off of high-priced U.S. technology stocks, the broader S&P 500 hasn’t shifted very much. That could soon change.

It appears that temporary factors tied to the pandemic are making investors reluctant to move beyond the handful of mega-cap winners, mostly in tech and social media, that have dominated the S&P 500 for the past 10 years. Investors seem skeptical about the trajectory of the pandemic this fall; they are also wondering if and when the next round of fiscal stimulus will pass, and are concerned about the outcome of the U.S. general election.

We expect these near-term uncertainties to subside in the next four to eight weeks and the traditional recession playbook, where a broader group of value-oriented cyclical sectors assumes market leadership, to take hold. Here are three main reasons why:

• Economic growth is improving. We see the V-shaped economic recovery as not only sustainable, but occurring faster and stronger than we originally forecast. Our economists now forecast that global activity could return to pre-COVID-19 levels by the fourth quarter of this year, and U.S. activity could do the same by mid-2021. Manufacturing, housing and employment are all rebounding.

• More stimulus is coming. It’s clear the supplemental unemployment payments in the last COVID-19 relief package spurred consumer spending and saving. We expect a new round of stimulus this fall to continue those trends. That could turbocharge earnings for traditional cyclical players that tend to have high fixed costs, while having limited impact on the digital leaders that likely pulled forward future growth during the shutdown period.

• S&P 500 earnings expectations are rising. Morgan Stanley  Chief Iinvestment Officer Mike Wilson has noted that, in the past three months alone, consensus S&P 500 forward earnings estimates have risen from $142 a share to $154 a share and could rise to the $166 to $170 a share range by the beginning of next year. Plus, the assortment of companies seeing upward revisions is quite broad—another positive sign. Earnings revision breadth usually correlates with market breadth, but that hasn’t been the case lately. In fact, the market-cap weighted S&P 500 Index and its equally weighted counterpart are at a historically wide dispersion for a recession. That suggests opportunity for investors, as lagging sectors catch up.

To be sure, the economic risks that are keeping investors focused on familiar growth names are real. But we think that governments and companies are more likely to persevere than close down, if the virus spreads further this fall.

We also believe that politics may be playing a role in the delay of the next round of stimulus. We expect higher unemployment checks to be sent, just as ballots are being cast. While we do think that the market could sell off given a delayed presidential election result, in our view, that scenario could prove short-lived and may present a buying opportunity.

We recommend that investors prepare now for the robust economic rebound we see coming in 2021 by stock-picking among cyclical and high-quality growth names that currently trade at reasonable levels.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from Sep 14, 2020, “Waiting for the Leadership Shift.” Ask your Financial Advisor for a copy or find an advisor. Listen to the audiocast based on this report.