Positioning for Reflation
Nearly a year ago, it felt like almost everyone was buying FAANGs and technology-based stay-at-home stories. Growth stocks outperformed value stocks by the largest discrepancy in decades in what appears to be the biggest dichotomy since the dot-com era of 1999-2000.
While many hope to see everything return to normal, the COVID-19 pandemic has forever changed the way we live, work, interact, spend, and invest. The pandemic has accelerated some of the technology trends that would have happened anyway. But it has also created overbought conditions in many of the growth-related names. The structural stay-at-home theme is probably far from over as the secular growth theme will return to favor. However, our recent SCTR studies suggest investors continue to favor the reflation trade over the Technology/growth call.
Here is the timeline of the investment shift toward the reflation trade.
Year-end 2020 – Consumer Discretionary, Industrials, Technology, and Financials
Toward the year-end, 11/23/20, we compiled another list of the top 100 SCTR list. The promising results on the vaccine front gave investors hope for a sustained economic recovery. Investors began to shift their investment exposures toward many reopening stocks and away from the stay-at-home plays. On 11/23/20, a review of the top 100 large-cap list ranked by SCTR scores shows economically sensitive sectors beginning to dominate the list. For instance, the largest concentration of stocks comes from Consumer Discretionary (26 names), Industrials (21), Technology (16), and Financials (9).
Beginning of 2021 – Consumer Discretionary, Financials, Energy, Technology, and Industrials
On 2/23/21, another SCTR study on the top 100 technical ranked names displayed an accelerating trend favoring reflation sectors (i.e., Consumer Discretionary and Industrials). However, it also showed two new themes emerging – rising interest rates (Financials) and rising inflation (Energy). A review of the top 100 SCTR list on 2/23/21 shows two S&P sectors dominating half of the list – Consumer Discretionary (28 stocks) and Financials (25 Financials). It is reasonable to expect Consumer Discretionary stocks to gain grounds because of the reopening trade. We were pleasantly surprised to see the Financial sector moved to the second dominant S&P sector, as only 9 S&P Financial names made it to the top 100 SCTR list on 11/23/20. The rotation occurred as the result of higher interest rates and the investment shift from growth to value.
Energy (12), Technology (11), and Industrials (10) accounted for another 33 names within the top 100 SCTR list. Also, within the top 20 SCTR list, there were 8 Consumer Discretionary names, and 4 Energy 4 Communication Services (i.e., Entertainment and Publishing).
It is interesting to note no Technology names made it to the top 20 SCTR list, suggesting investors continue to favor the reflation trades over the structural growth sector trade, at least from a near-to-medium term perspective.
End of 1st Quarter 2021 – Financial, Consumer Discretionary, Energy, and Industrial
With one week before the end of the 1st quarter, on 3/24/21, another SCTR study on the top 100 technical names continues to suggest investors favor the reflation trade trend. The S&P Financial sector moved into its leadership role with 29 stocks within the top 100 SCTR list. The Consumer Discretionary slipped slightly into second place with a respectable 20 names. The Energy and Industrial sectors continue to gain sponsorships with 13 stocks and 12 stocks, respectively. Within the top 10 and the top 20 SCTR lists, the same reflation theme dominates the two smaller lists. Consumer Discretionary sector (4 stocks within the top 10 list) and 7 stocks within the top 20 list), Energy (2/5), Financial (1/4), and Communication Services (2/3). Like the prior SCTR study, Technology stocks failed to place on the top 10 and 20 SCTR lists. Nonetheless, a deeper dive still shows 9 Technology names residing within the top 100 SCTR list with 3 Semiconductors and 3 Computer Hardware stocks.
After four years of inflation rates below two percent, the US economy appears to be entering a period of reflation. Reflation is a critical turning point in the economic cycle. It is the first phase of the economic growth cycle toward rising inflation. If the economy is finally entering into a reflation regime, then the rotation toward commodities, cyclical sectors, financials, industrials, and small-cap companies is sustainable. While a substantial rise in yields tends to lead to some stocks becoming less attractive, overall stocks tend to benefit from higher economic growth. The above SCTR studies over the past few quarters suggest the reflation trade has legs and is a sustainable intermediate-term investment theme.