The "K-Shaped" Recovery - Betting on the Second Leg, the Broader US Recovery

Insights

The "K-Shaped" Recovery - Betting on the Second Leg, the Broader US Recovery

QS RESEARCH GROUP

AUGUST 25, 2020

 

The S&P 500 Index reached a historic high on February 19th of this year, only to break that record less than six months later. On its face this sounds reasonable, however when considering the unprecedented nature of the events that transpired in-between, this is downright shocking. Over this six-month period the S&P 500 realized its swiftest decline in history, contracting over 30% in less than 22 trading days, putting an end to the 11-year bull market, as 9.5 years of job gains were wiped away in less than a month. The US government passed a $2 trillion relief package, the largest stimulus in history as the Fed slashed interest rates near zero. In the meantime, the US economy shrank by an annualized 32.9% quarter-over-quarter on an annualized basis, the largest ever recorded contraction.

While all these cataclysms occurred, the S&P 500 index continued to climb from its March 23rd lows.  There was much discussion on whether this rebound would be V-shaped (a quick decline followed by an even faster recovery),  U-shaped (taking months, if not years to fully recover), or even W-shaped (whereby the economy begins to recover rapidly but then falls into a second period of decline). When we categorize the various components of the index, what the market recovery to date has really ended up looking like is a K, a bifurcated recovery with two lines diverging on a chart. What are those two lines you may ask? It could be anything from the NASDAQ vs the S&P 500 Index, US Large Cap vs US Small Cap, or Growth vs Value. 

EXHIBIT 1: NASDAQ VS. S&P 500


Source: Bloomberg, cumulative daily returns. Indices as of August 18, 2020.

EXHIBIT 2: GROWTH VS. VALUE

Source: Bloomberg, cumulative daily returns. Growth is represented by the Russell 1000 Growth Index, and value by the Russell 1000 Value Index. Indices as of August 18, 2020.

EXHIBIT 3: SMALL CAP VS. LARGE CAP

Source: Bloomberg, cumulative daily returns. Small cap is represented by the FTSE Small Cap Index, and large cap by the Invesco S&P 500 Top 50 ETF. Indices as of August 18, 2020.

Winners and losers at this point are still defined by those that did well during the pandemic - internet retailers, tech-enabled social media and remote working platforms - versus those which had to virtually cease operations as 95% of Americans were under stay at home orders - restaurants, resorts/hotels, airlines and movie theaters. While 300 stocks in the S&P 500 still lie in negative territory, the top five stocks by size (Apple, Microsoft, Amazon, Facebook and Alphabet) are up approximately 40% on average for the year. However, these 300 companies make up only 37% of the S&P 500 Index by market cap, whereas the top five companies represent 23% of the Index. Big Tech has only gotten bigger. Looked at in a slightly different way, without three companies - Amazon, Apple, and Microsoft - the return on the S&P 500 including dividend payments would have been -4.1% this year through the end of July. Instead, the S&P 500 returned 2.4%. Earnings and sales for the broader market have fallen over the last six months and as a result the market now looks even more expensive than it did before.

EXHIBIT 4: TRAILING P/E RATIO

Source: Bloomberg, S&P 500. Growth is represented by the Russell 1000 Growth Index, and value by the Russell 1000 Value Index. 

This begs investors to question where to put money next? We believe now may be the time to invest in a comprehensive recovery, the second leg of the ‘K’. Value-oriented companies with strong sustainable dividend profiles now trade at an extreme valuation versus technology and tech-enabled consumer stocks. Not only do these stocks offer a significant source of income, but they provide exposure to the broader US recovery at an attractive price. In the US, value stocks have, on average, outperformed by 730 basis points in the 12 months following a trough in the business cycle.[1]

[1] Source: NBER, Ken French.  Data from 1927-present.

IMPORTANT INFORMATION

This material is intended for informational purposes only and it is not intended that it be relied on to make any investment decision. It was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. It does not constitute investment advice or a recommendation or an offer or solicitation and is not the basis for any contract to purchase or sell any security or other instrument, or QS Investors, LLC to enter into or arrange any type of transaction as a consequence of any information contained herein. QS Investors, LLC does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this document. Except insofar as liability under any statute cannot be excluded, no member of QS Investors, LLC, the Issuer or any officer, employee or associate of them accepts any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage whether direct, indirect, consequential or otherwise suffered by the recipient of this document or any other person.

The views expressed in this document constitute QS Investors’ judgment at the time of issue and are subject to change. The value of shares/units and their derived income may fall as well as rise. Past performance or any prediction or forecast is not indicative of future results. This document is only for professional investors. Investments are subject to risks, including possible loss of principal amount invested.

QSCR-19147 (August 2020)