OB Report
December 2020
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Light at the End of the Tunnel

Murray Leith By Murray Leith CFA, Executive Vice President & Director, Investment Research

light-tunnelDespite the controversy around the U.S. election and the worrisome spike in COVID-19 cases, stocks have moved higher. In fact, the rate of appreciation has accelerated recently. Since Americans went to the polls on November 3 through to November 13, the main Canadian and U.S. equity benchmarks rose 4.7% and 6.4%, respectively.

What’s interesting, remarkable and downright encouraging is the shift in market leadership that occurred over those eight trading days. Advances in the first three days were led by growth stocks, while the gains over the latter five days were dominated by value stocks. The shift, highlighted in this chart comparing the performance of the Russell 1000 Growth and Value indices, suggests that there is light at the end of the proverbial tunnel and reason to believe that there is a stronger economy on the horizon.

In the three days immediately following the election, the Russell 1000 Growth Index shot up 5.9%, while the Russell 1000 Value Index rose an uninspiring 0.6%. The much-anticipated Democratic sweep of the White House and both chambers of Congress didn’t materialize, and with that fears of increased regulation, significant deficit-expanding government spending and tax hikes faded. With the Republicans likely to maintain control of the Senate, it will be much tougher for the Biden-led government to enact bold initiatives, including a much-needed COVID-related fiscal stimulus bill in the near term. Not only will it likely take longer to get additional support where it is needed, but individuals, businesses and state and local governments will probably receive less aid than hoped.


While that is bad news for the economy, it renders growth stocks more attractive for two reasons. First, the relative appeal of growth stocks increases in a slow-growth world because growth is scarcer; the premium for companies that can deliver growth in an anemic economic environment tends to increase. Second, less fiscal stimulus probably means the monetary authorities will keep interest rates ultra-low for longer and inject more liquidity into the financial system. Mathematically, the valuations of higher growth businesses benefit disproportionately from lower interest rates.

The optimism around growth stocks halted abruptly on Monday, November 9, with promising vaccine news from Pfizer fueling a significant rotation from growth to value stocks. The moves that day were massive, and for the week the Russell 1000 Value Index surged 5.2% as the Russell 1000 Growth Index dropped 1.2%. While the enthusiasm toward value stocks has faded somewhat since, much as it did following other false starts for value stocks earlier in the year, the recent and sudden shift in investor sentiment felt different.

Companies that have suffered the most from lockdowns – airlines, cruise ships, retailers, hotels, restaurants, energy firms and banks – experienced unprecedented one-day upward moves in their share prices. While we remember many days when stock prices dropped dramatically, we can’t think of a single occasion when the outsized moves were so broad and to the upside.

This remarkable market action was possible due to the extreme valuation spread between the so-called “stay-at-home” growth stocks like Amazon, Netflix and Microsoft, which have benefited from lockdowns, and the “get-out-and-about” value stocks, which have suffered. Moreover, the rotation was encouraging because it was a signal that there will eventually be a return to normalcy.

We are not suggesting it’s time to break out the champagne, as there are many factors that could undermine the economic recovery and rattle investor sentiment in the near term.

While the preliminary test results indicate that vaccines being developed by Pfizer Inc. and Moderna Inc. are more effective than many hoped, the U.S. economy still has an urgent need for additional government support. President-elect Joe Biden is urging Congress to approve stimulus legislation before he takes office, yet President Donald Trump is more focused on fighting the 2020 election results than governing. Lawmakers have not passed new aid in months, and as the virus again overwhelms hospitals and forces state and local officials to restrict economic activity, Republicans and Democrats have not budged from their divided positions on stimulus. With earlier aid programs running out, the stalemate creates a very real risk that the economic recovery will relapse in the near term. Indeed, data from credit card companies suggests that consumer spending is waning even as the holiday season approaches.

As of this writing, President Trump is refusing to concede the election, and his administration isn’t coordinating with the Biden transition team on important matters such as national security, the COVID-19 pandemic and vaccine distribution plans. The safety of the promising vaccines has yet to be established, and the lack of a smooth government transition undermines public confidence in the approval process. That’s disturbing, as the success of the vaccines is dependent on their effectiveness, safety and widespread adoption.

While pandemic, political and economic uncertainty could bring near-term stock market volatility and weakness, it’s equally possible that stocks will remain buoyant as investors focus on the prospect that vaccines and better treatments will ultimately help society return to normal. There is light at the end of the tunnel, and in our view it is only a question of when the world gets past the pandemic, not if.

The stock market is forward looking, and analysts are increasingly anticipating better economic growth and stronger corporate profits in the latter part of 2021 and into 2022. We think their optimism is warranted.

While it’s hard to handicap whether popular growth stocks or depressed value stocks will outperform over the next few months, the odds are very good that out-of-fashion stocks will stage an impressive comeback over the next few years. Leadership will likely broaden from the narrow group of so-called FAANGM stocks – Facebook, Apple, Amazon, Netflix, Google and Microsoft – that have dominated market performance in recent years.

Because we have long advocated a balanced and diversified approach, we are not recommending any bold shifts in portfolio strategy. Our Odlum Brown Model Portfolio1 holds both growth stocks and value stocks, including businesses that have been helped and hurt by the pandemic. With a modest tilt toward stocks with value-type characteristics compared to a blended 50/50 Canada-U.S. equity benchmark, we are well positioned to benefit as the light at the end of the tunnel brightens.

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1 The Odlum Brown Model Portfolio is an all-equity portfolio that was established by the Odlum Brown Equity Research Department on December 15, 1994, with a hypothetical investment of $250,000. It showcases how we believe individual security recommendations may be used within the context of a client portfolio. The Model also provides a basis with which to measure the quality of our advice and the effectiveness of our disciplined investment strategy. Trades are made using the closing price on the day a change is announced. Performance figures do not include any allowance for fees. Past performance is not indicative of future performance.

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