Welcome to RBC’s Markets in Motion podcast recorded August 9th, 2021. I’m Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers. This week in the podcast, we update our longer-term thoughts on how to be positioned within the US equity market through 2022, which is really where our conversations with investors have been focused over the past few weeks.
Three big things you need to know:
- We expect the Growth/Value trade to stay choppy through 2022, with a major peak in Value relative to Growth in 2022.
- We are making a few changes to our sector recommendations, getting more balanced between Value and Growth in our S&P 500 sector overweights.
- High quality leadership has returned to the US equity market, supporting our Large Cap Tech upgrade.
If you’d like to hear more, here’s another five minutes. While you’re waiting, a quick reminder that you can subscribe to this podcast on Apple, Spotify and other major providers.
Now, the details.
Slide 2
Starting with takeaway #1: I think the style trade is going to stay choppy through next year. Once current pressures on Value resolve, we see another outperformance trade in Value in the intermediate term, but think that will probably be the time to get out before Growth takes over leadership again.
- Near term, Value is confronting a number of challenges – earnings revisions look better in Growth than Value,
Slide 3
- ETF flows have turned stronger in Growth again,
Slide 4
- Growth/Nasdaq no longer looks crowded in the futures market,
Slide 5
- and bond market signals are creating some confusion about the macro in the eyes of equity investors – the yield curve has been flattening and Value tends to underperform when that happens due to its Cyclical bias.
Slide 6
- Most importantly, since March the Growth/Value trade has been moving in sync with trends in US COVID cases – when the trend in case counts began to deteriorate, the Value trade peaked and as case counts surged Value saw a big bout of underperformance.
Slide 7
- Once these clouds clear, the stage seems set for another burst of Value leadership later this year or early next.
- Value still looks cheap relative to Growth,
Slide 8
- Value looks much better than Growth on buybacks and dividends,
Slide 9
- and Value tends to outperform when real GDP growth is tracking above average, which is still expected to be the case in 2021 and 2022 – next year is tracking at 4.2% among the consensus track by Bloomberg vs the LT average of 2.5%.
Slide 10
- On COVID, while the number of US COVID cases has continued to rise, the good news is that the rate of change in new case growth has decelerated, helping the Value trade stabilize since mid-July.
- And while this could change quickly, the high frequency indicators they are holding up reasonably well.
- That argues the inflection back to Value might happen sooner than some of the challenging COVID headlines would otherwise suggest.
- The stock market reaction to Friday’s strong jobs report, which saw Financials and Value move up sharply, was also a good reminder that clear signs of economic strength retain the power to be a positive catalyst for Value.
Slide 11
- But even though we get very excited about the idea of another big pop in Value, we think it’s likely that will be Value’s last hurrah because of two things we see in the outlook for late 2022 and 2023.
- First, real US GDP growth is expected to slip back down to slightly below average levels of 2.3%. Historically, Growth outperforms Value when real GDP growth is tracking below average.
- Second, many equity investors expect the Fed to starting hiking in late 2022. Historically, Value usually beats Growth going into hikes, but Growth starts to lead again during hikes.
Slide 12
Takeaway #2: How do we want to express this view of choppiness in the style trade in our sector views? All year we’ve been heavily leaning into Value sectors, but going forward we want to have more of a balance between Value and Growth.
- We’re keeping our overweights on two Value sectors – Financials and Energy.
- In addition to their cyclical trading behavior, valuations are deeply compelling for both sectors,
Slide 13
- We also like the buyback angle for Financials, and
Slide 14
- And we also like the high dividend yield and strong earnings revisions in Energy.
Slide 15
- But we are pulling off our overweight on a third Value sector – Materials, which we are lowering to market weight.
- Mostly this is about dialing down the cyclicality.
- Earnings revisions have also turned weaker for Materials than both Energy and Financials recently.
Slide 16
- At the same time we are pulling up Technology to overweight from market weight.
- This is our Growth pick, but as a reminder, the Tech sector does not include the big Internet names.
- In addition to its counter cyclicality – it tends to outperform when the yield curve flattens,
Slide 17
- When 10 year yields fall,
Slide 18
- and when inflation expectations decline.
- We also really like this sector’s earnings profile – it continues to be one of the best sectors for upward revisions.
Slide 19
- Valuations are admittedly still a problem for the broader sector – but that’s really driven by Software & IT Services.
- Semis & Semi Equipment, Communication Equipment, and Hardware look reasonable or cheap on a relative P/E.
Slide 20
- Those industries also have stronger earnings revisions trends than most industries in most sectors.
Slide 21
I’ll wrap up quickly with takeaway #3: high quality is starting to lead again.
- Rising uncertainty on COVID and the macro has triggered the return of leadership by high quality within the US equity market.
- We see this on most of the quality factors we track for the Russell 1000 and 2000 - ROE, leverage, market cap, short interest.
- That’s normally what happens in the 2nd phase of a recession recovery.
- The transition back to high quality is usually pretty bumpy, and history suggests low quality will probably have one more brief moment in the sun. But over time, high quality tends to fare best.
Slide 22
- I bring this up because it is relevant to our sector changes today.
- We have recently built a new quality scorecard in which we rank the different sectors on the four quantitative quality metrics that we track.
- Tech was the top quality sector overall, coming in the top 3 on all 4 metrics.
- Financials scored surprisingly well, ranking highest among the Value sectors.
That’s all for now, thanks for listening, and please reach out to your RBC representative with any questions.