A standard recession doesn’t just upend the economy. It cleans out the excesses in markets, turning winners into losers and, sometimes, losers into winners.
This time is different so far. Rather than breaking the habits investors fell into during the bull market, the coronavirus crisis and economic shutdown have reinforced two of the biggest trends in stocks: U.S. technology and “quality” stocks, those with a steady earnings record, continue to beat the market.
The relative success of some of the most expensive stocks on the planet undermines the argument made by many of a bearish persuasion that the all-time highs set earlier this year were part of a bubble in high-growth stocks. At the very least, that bubble has yet to pop.
That isn’t to say that there was no froth. Some of the most fashionable stocks were crushed in the bear market from February’s high to the March low. Beyond Meat (BYND) and Tesla (TSLA) are the leading examples: They fell about 60%, double the loss of the S&P 500 (.SPX). Both have rebounded as the market recovered. Tesla is up 78% for the year and Beyond Meat is just slightly down, while the S&P is still down 13% in the year through Thursday.
Unlike these frothy shares, high-growth stocks have beaten the wider market in good times and bad for more than a decade, including this year.
“Normally in a bear market the previous winners get hit the most,” says Peter Oppenheimer, chief global equity strategist at Goldman Sachs. This time, the economic shock has accelerated fundamental shifts already in place, such as the decline of bricks-and-mortar retail and the move to cloud-based software.
The weak expansion of the past decade increased the attraction of companies that could tap technology to grow, while leaving traditional companies reliant on the economic cycle in the dust. The move into recession hit those traditional cyclical stocks even harder, while many growth stocks were less badly hit. Some even benefited, such as video-streaming service Netflix (NFLX), which hit a high this week, or biotech companies trying to find coronavirus cures.
The other big winners have been high-quality companies. It shouldn’t be surprising that stocks with little debt, steady revenues and reliable earnings appeal during a recession. But they did well in the good times, too, far outperforming the S&P 500.
Quality has a big overlap with the high-growth stocks, as technology makes up almost half of the MSCI USA Quality index. Some of the biggest quality stocks have been winners from the shutdown, too: Microsoft (MSFT) with cloud computing, Johnson & Johnson (JNJ) on the hope of a vaccine and Procter & Gamble (PG), maker of toilet paper among other stockpile essentials.
Jean Boivin, head of the BlackRock Investment Institute, says the normal end of a business cycle corrects financial excess and leads to stock-market reversals.
“This is a very different type of shock that’s hitting now,” he says. “It’s not a dynamic where there have been imbalances that were building up or bubbles that were waiting for some spark to trigger a correction.”
It wasn’t just in the stock market’s rapid fall that its winners and losers were unusual; the recent rebound, too, has been odd. Cheap “value” stocks again are lagging behind the broader market, the lowest-volatility stocks in the S&P are doing better than high-volatility stocks and smaller companies are rising less than big companies after falling more in the crash.
Damian Handzy, chief commercial officer at research firm Style Analytics, is skeptical that the rebound is anything more than a bear-market rally, albeit a big one. He says the best performers in the early stage of new bull markets tend to be volatile smaller stocks: “Crashes all look a little bit idiosyncratic but recoveries tend to look the same.”
Investors who trust the market can find plenty of reasons for why stocks aren’t following a standard recession template during the coronavirus lockdown. Equally, investors who thought it was all a bubble inflated by easy money have little reason to change their belief, as central banks are pumping in more than ever to keep asset prices afloat.
I think both are right: Stocks are being driven by their fundamentals and by the Federal Reserve. That doesn’t mean there is a bubble in expensive growth stocks. If the Fed somehow falls under the control of hawks and withdraws stimulus, the market would surely collapse. But I see zero chance of that happening as long as the economy remains in trouble.
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