Throughout this pandemic, there have been two big capital market themes that we have been paying close attention to and highlighting in our updates: the dispersion between growth (predominantly tech) and value names, and the re-opening of the U.S. economy. Here is an update and our latest thoughts on where we stand in both of those cases, especially how closely tied they are to one another.
As you can see below, the Goldman Sachs “Re-opening of America” scale remains at a 4.
The team at Goldman Sachs is seeing a lot of eCommerce deliverers, streaming media, and video chats taking place of concerts, travel, and time in the office. Recent COVID-19 flare-ups have forced cities and states to pause or go back on their re-opening plans. However, we are seeing some positives coming from beat-up sectors such as cruises and retailers. On their earnings call, Royal Caribbean Cruises reported that 2021 bookings are trending towards historical levels, with 60% being new bookings and 40% are done using cruise credits from this past year. Second-quarter sales numbers from retailers' earnings (such as Capri, Kontoor Brands, and YETI) have continued to exceed expectations; however, management commentary remains cautious. Capri and Ralph Lauren pointed out that for their sales to truly recover, tourism will need to bounce back as they have a big presence in travel retail. We can see from the below chart from JP Morgan that travel remains light compared to the same time last year.
One of the bigger questions that is on the minds of investors is whether the equity market is overvalued. This is a very reasonable question to ask – as we see below, once more courtesy of JP Morgan, the forward price to earnings ratio on the S&P 500 is close to the same levels we saw during the tech bubble:
Now, the high valuation is a byproduct of the run-up in growth names, typically the ones that do have a higher P/E ratio than their peers. A recent Morgan Stanley report shows that the five largest stocks in the S&P 500 are now 23% of the entire index. Before the tech bubble burst in 2000, the top five largest companies accounted for 18%. There are a couple of different of scenarios that can unfold from here: a tech sell-off due to poor tech earnings (highly unlikely if we continue to predominantly stay at home), a broad market sell-off due to an exogenous shock (geopolitical risk, elections, etc.), or rotation out of tech and into previously sold-off names – a sign that investors believe that we are close to reaching the other side of this pandemic.
Concerning the various market risks - Goldman Sachs identified seven of them and have been tracking them throughout this crisis. Those risks are funding risk, liquidity risk, US Growth risk, China growth risk, European sovereign risk, oil price risk, and Fed policy risk. As you can see in the chart below, those risk factors have recovered significantly from their March lows. The reduction in overall risk has been a big contributor to the recovery of global risk assets.
The first part of market recovery was driven by reduction of funding and liquidity risks while subsequent recoveries have been due to the re-opening of the economies. This is where it’s important to keep an eye on the US Growth risk factor. Any time we have seen optimism about the US recovery, we have had a cyclical rotation out of growth names and into sold-off names that are predominantly considered "value” (like June) and over the past month:
Ultimately, there is still a lot of ways this can go sideways. We have rebalanced our portfolios to get them back to their long-term weight to best protect on the downside. We will continue to monitor the investing landscape to determine if and what necessary changes are needed.