THE “SWEET 16” BIG TECH STOCK RALLY IS OVER. IT’S TIME FOR CYCLICALS TO OUTPERFORM TESLA AND APPLE
by Collin McClelland
Technology stocks that powered the stock market’s resurgence during the pandemic may be running out of steam, and are being replaced by cyclical shares — companies poised to boost earnings because of improved economic conditions, according to Jefferies Research Services LLC.
Jefferies’ ‘Sweet 16’ index of major tech stocks including Apple Inc., Microsoft Corp., Amazon.com Inc. and Alphabet Inc., the parent of Google, has shed 13 per cent of its value since a Sept. 2 high while accounting for 45 per cent of the S&P 500’s decline and a “whopping” 79 per cent of the fall by the benchmark Invesco QQQ exchange traded fund during the same period, Jefferies equity strategist Steven DeSanctis wrote in a note Thursday.“We remain firmly in the camp that the cyclicals should outperform, and they have from the low in small caps and doing so in large (caps) month-to-date,” DeSanctis said. “Just looking at the “other” 485 stocks in the S&P 500, the earnings and sales revision ratios are heading higher on a three-month basis, slightly weaker on the one-month like the Sweet 16, and this reflects a better macro backdrop.”
Cyclical stocks are companies that make or sell discretionary goods and services that are in demand when an economy is doing well, such as restaurants, airlines, furniture and car makers.Global markets are in the midst of their highest volatility since July as uncertainties reign over economic stimulus packages, renewed lockdowns and vaccines to combat the virus, while a deeply contested U.S. election marked by a Supreme Court vacancy has rattled bulls.
Wall Street rallied in a rocky session on Thursday as beaten-down technology shares gained favour after data showed a surge in the sale of new homes revived faith in the economic recovery even as U.S. jobless claims rose unexpectedly. Apple Inc, Amazon.com Inc, Nvidia Corp and Facebook Inc, stocks that had taken a beating lately, all rose. The Dow Jones Industrial Average rose 0.19 per cent, to 26,814.78, the S&P 500 gained 0.30 per cent, to 3,246.52, and the Nasdaq Composite added 39.28 points, or 0.37 per cent, to 10,672.27. The S&P Composite TSX Index also rose 0.60 per cent to 15,912.26.Despite the one-day rally, Nasdaq remains in correction territory and markets will remain choppy, notes Mark Haefele, UBS Global Wealth Management’s Chief Investment Officer.
“There are strong reasons to diversify beyond the traditional U.S. mega-cap stocks,” said We currently like companies involved in the rollout of 5G,China’s new economy, and healthtech,” Haefele wrote in a note. “In addition, given the global shift toward a focus on sustainability, especially the EU’splan for a “green recovery,” we favor a sustainable investment approach to diversifying for the next leg.”
Jefferies sees an improving economy that should shift investors to cyclical stocks because the sales and revenue growth that propelled tech stocks over the last several months historically wanes when the economy improves.“The macro environment is getting better with yesterday’s Purchasing Managers’ Index numbers in the U.S. very strong, the Institute for Supply Management’s manufacturing index continues to move higher, and retail sales has been strong,” DeSanctis said. “This creates a really nice tailwind for our “Get Cyclical” positioning.”Nonetheless, the Sweet 16 remain strong, having been market darlings as far back as 2017 and are up 54 per cent this year despite this month’s 13 per cent pullback, DeSanctis said.
Jefferies forecasts U.S. economic growth of more than 4 per cent next year, maybe closer to 5 per cent, that will broaden earnings and revenue growth across sectors, negating the scarcity of growth that pushed tech stocks higher.
History shows when the economy grows faster than 4 per cent, the market overall has averaged a gain of 12.6 per cent versus 10.6 per cent for the fastest revenue growers, the analyst said. Those sales growth stars are in danger of overvaluation now, he said. Although they have outperformed the market over the last 12 months by 14.7 per cent, they now trade at 8.6 times sales, a multiple last seen in October 2000 during the dot.com bubble crisis and nearly 200 per cent above its long-term average, he said.
“We have never been a believer of sales growth as a factor, as these names tend to get tripped up by having too high expectations and a few bad apples spoil the bunch,” DeSanctis said. “When looking at 2021’s earnings and sales growth, we see that the ‘rest of the S&P 500’ is expected to deliver much better earnings growth than our ‘Sweet 16’ and this number has only been trimmed from one-month ago.”