Market Playbook Creates Opportunities -Terry Gardner, CJ Lawrence Market Comment 2.24.2021 – YouTube Video & Transcript

In this video, Terry Gardner discusses the changes in the stock market backdrop, industry group rotations below the index level, and why winners can keep winning.

https://youtu.be/NFD5vcRwwOA

Video Transcript

Hi, good afternoon, everyone. It’s Terry Gardner from CJ Lawrence on Wednesday, February 24 with some market commentary coming to you today from the CJ Lawrence Satellite Office. Looking forward to getting back outside soon for some outdoor market commentaries, but today, we want to cover five topics. First, we want to take a look to see what has changed in the market environment since the beginning of the year. Secondly, we want to talk about the market playbook. Third, we want to go inside the market below the index level and see what is taking place at the industry and sub-industry group levels. And fourth, we want to make the point today that winners can keep winning. Finally, we’re going to wrap up with a discussion of previous interest rate cycles and whether or not a rising rate environment is more bark than bite for stock prices.

Terry Gardner:

So first off what’s changed in the new year? Well clearly the interest rate and inflation expectations environment has changed. The 10-year US Treasury Yield is now hovering around 1.4%. That’s well above where it was in the third and fourth quarter of last year. And it’s not necessarily the absolute level that bothers the market, it tends to be the rate of change. So while 1.4, 1.5% is still near 50-year historical lows, the 10-year Treasury Yield is up 55 basis points in just the last three months and that’s a rapid rise. Well, inflation has been tamed for the past decade. We’re starting to see that signs that inflation and inflation expectations, which really matter to the market are creeping higher. In fact, we’re starting to see 2021 and 2022 forecast eclipse 2% for the first time in several years. So, that’s something that bears watch.

Terry Gardner:

So what does that all mean for the stock market? Well, that’s kind of leads us to our point. Number two, that the market follows a playbook. The market oftentimes follows a big if, then logic statement. If the macro environment changes, then the following rotations take place and asset allocation adjustments take place. And I think that’s what we’re seeing some of now. And sometimes those adjustments, those shifts, those rotations happen without much consideration for the underlying fundamentals of the underlying groups and companies in the indices.

Terry Gardner:

The point that I’m also trying to make is that the market has shifted over the last several years towards passive investing or maybe shifted back Bank of America, Merrill Lynch, in a study last year suggested that 45 to 50% of the average volume on the US Exchange is traded daily is controlled by passive investment vehicles, whether they be ETFs, or investment funds, that has ramifications for underlying securities because when you get these big shifts and you get changes in the macro, when interest rates start to rise, inflation expectations start to rise that triggers asset allocation shifts, sector rotations, style shifts from growth to value that has impact on the underlying securities.

Terry Gardner:

And we may be seeing some of that in the market today. So we’re going to, as our next point, we’re going to take a look underneath the index level to see what is happening with groups and with sub-industry groups and industry groups. So we did some analysis of the S&P 500, as we talk on our videos regularly, we typically look at the 11 major sectors of the S&P 500. For this analysis, we went down to the 64 industry groups, and then I think there’s 147 sub-industry groups to see where the flows were shifting in and out of these groups. And there were some interesting takeaways from the analysis. When I look at the top of the list of year to date performance, actually, let moved back up a step, not year to date, but what we did was we started this analysis on January 27th, why the 27th? Because the year started with interest rates creeping a little bit higher than 1% at the 10-year government bond level started to fall back again.

Terry Gardner:

And on January 27th, the 10-year government bond kissed 1% and shot higher and hasn’t looked back. So if you start the analysis on the 27th, it gives you a pretty interesting picture of what the downstream impacts are on the different S&P groups and sub-industry groups. And with regard to their fundamentals, when I look at the top of the list of performance. So since January 27th, you see groups at the top of the list, like casinos and gaming up 35% for the year. Despite the fact that earnings for that group are supposed to decline, will be 11% below where they were even in 2019. So that’s a two year stock we talk about, we kind of threw out 2020 and said, okay, what do earnings look like in 2021 versus 2019 as a baseline and earnings will be below 2019 levels in that group by 11%. Hotels, resorts cruise lines.

Terry Gardner:

That group is up 29% since January 27th. Despite the fact that earnings on that two year stock will be down 30%. other industry group… Airlines, similar up 27% for the price, earnings expectations down 30% on two year analysis. And I can go through a number of others, there’s a lot of oil and gas names at the top of the list. You know, typically following oil prices and natural gas prices, but also getting a lift because the expectation is that as the economy recovers consumption will rise, perhaps outstripping demand, while prices will continue to rise, and these companies will make money. So they’ve done particularly well in the beginning of this year, as have banks, banks as a group up 19% in price and expecting 30% increase in earnings over that two year stack. What does it look like at the other end? What sub-industry groups, industry groups are lagging or even gone negative for your couple are interesting I think.

Terry Gardner:

The internet direct marketing retail group, which contains Amazon is flat for the year, despite the fact that, that earning stack 21 over 19 is up 53%. Also down for the year life science tools, down slightly earnings expected to grow 50% and there’s a few others. So what you’ve seen is the buyers come in and swoop up a bunch of industry groups, sectors that have underperformed, but according to the playbook should do well as the economy recovers. Despite the fact the fundamentals underlying many of these companies are poor. What does that create? It creates an opportunity for active investors, like we at CJ Lawrence to find names that have sold off based on the rotation, based on the shift that have excellent fundamentals that we want to own and own for the longterm. So this becomes the dichotomy between a sector and a rotation trade versus an investment. The market is trading is shifting, but it’s also creating great investment opportunities for longer term focused investors. So, that analysis is available if you’re interested.

Terry Gardner:

The fourth point that we wanted to make in our video today is that winners can keep on winning. So it’s oftentimes points like this in the market where investors will say, you made a lot of money in this particular stock or this particular group, and they want to sell them and rotate them to something else that hasn’t yet worked that may for the next leg. There’s nothing wrong with trimming positions and rebalancing portfolios. That makes a ton of sense to us. We certainly do it, but we do caution others about selling winners when they can keep winning. And so we took a look at two paths, recent spikes in interest rates to see how stocks did and to see what groups, what sectors led the market during those two periods.

Terry Gardner:

More recently, I think this is appropriate because these are very recent periods who again, were looking at the 10-year Treasury Bond Yield and in the period between July 8th, 2016 and December 16th, 2016. So kind of the back half of 2016 and 10-year Government Bond Yield went from 1.36 to 2.55. You would expect that the market would struggle during that jump in interest rates. But in fact, over the 12, 12 month period from the beginning of that move the market and S&P 500 returned, 13.2%. The next period we looked at was September 8th, 2017, to October 5th, 2018. During that period, the 10-year Treasury Yield rose from 2.04% to 3.23%. It’s remarkable we’re complaining about one and a half percent government bond yields on the 10 year when in 2017 and ’18, they were over 3%, but that’s where we are. So during that period, again, 2.04% to 3.23%, you would think that that rise in bond yields would really needle the market.

Terry Gardner:

And instead the S&P 500 during the 12 month period from the beginning of that move in interest rates was up 9.5%. What were the leaders during those periods? Again, rising rate environments, or at least the spike rate environments during both periods, the best performing sectors over the 12 month period, they may have struggled in month one, two, three, and even four. But over 12 months, the best performing sectors were number one technology and number two, consumer discretionary, which is heavily weighted towards Amazon. So winners can keep winning. And if you want to draw a football analogy to it while I was never a Tom Brady fan, because I’m a long suffering New York Jets fan, look at Tom Brady and Rob Gronkowski in The Super Bowl, right? Those are guys that people had kind of cast away as being yesterday’s winners. Well, guess what winners kept winning.

Terry Gardner:

So that’s point number four, which brings me to my final point about interest rates environments. And I’m just going to defer on this point to a piece that we wrote in October of 2018. If you go to our website, you’ll find a market comment that I wrote again, October 9th. And it is an analysis of past interest rate cycles there are fed phones, hike cycles. So not necessarily tied to the 10-year treasury, which is controlled by the market, but looking at fed tightening periods. But I think there’s some important parallels that we can draw. And in that analysis, I went through every rate cycle, back to the 1930s to look at what happened as rates rose to stock prices during that period. And I think it’s interesting analysis and important to consider as we look to higher rates in the current environment, so that’s what we’ve got for today.

Terry Gardner:

Certainly, it’s a good time to add some cyclical exposure, especially with companies that are industry leaders and innovators in cyclical industries. We’re certainly looking at them. It is awfully nice to have an innovator that has the wind in their sail from the economy as well, but we want them to maintain that healthy growth waiting as well, owning market share gainers and disruptors. So if you’ve got any questions about the analysis that I shared with you today, feel free to reach out to me. My email is tgardner@cjlawrence.com, or you can give me a ring at (212) 888-6403. Again, it’s Terry Garner from CJ Lawrence. Hope you have a great evening. Thanks.

Terry Gardner, Jr.:

If you have any questions about this or the Great South Bay give me a ring here at C.J. Lawrence. It’s Terry Gardner, (212) 888-6403, or shoot me an email at tgardner@cjlawrence.com. Have a great day, everyone.