The mid-single-digit percentage increases of the Dow Jones and S&P 500 indices during Q1 2021 seemed like a continuation of the strong performance of late 2020, but — according to Chris Armbruster, KAR Senior Research Analyst and Co-Manager of the firm’s Mid Cap Growth portfolio — very different drivers were at work under the surface.
Value Takes Lead Over Growth
While at KAR, we don’t adhere to a strict separation of the baskets of growth and value — the market has deemed any company with a strong growth profile as a growth stock. In contrast, any company with a cyclical or hesitant pattern is labeled as value. In 2021, value stocks have taken the leadership mantle away from the growth stocks that led the market late last year. We think there are two main factors in the changeover:
1. A Recovery Tailwind
Many value stocks rise and fall with macroeconomic growth, and the re-opening of the economy is giving them a strong tailwind. Meanwhile, growth has gone from scarce to ubiquitous and lost its luster in a matter of months.
However, as many of these growth companies have also spent a great deal of time and effort right-sizing their expense base, we feel the earnings leveraged from their improved topline might be underestimated.
2. Increasing Interest Rates
The anticipation of economic growth and inflation whispers have increased interest rates rapidly in Q1. This helps many value names, like banks, that earn interest income. We believe it also makes growth stocks less attractive, and they have exhibited a strong negative correlation to rising rates this year. Higher rates mean many investors discount growth stocks more heavily in calculating their current value.
2021 Stock Market Outlook — What We’re Looking For
Armbruster says his portfolio will be seeking two things:
- As always, the quality of the business. That is the most important factor over a long-term time horizon period; and,
- Errors in Wall Street’s judgment. For some companies, the street is not giving the rebound enough credit, and we believe performance estimates are off by orders of magnitude, which presents buying opportunities.
This information is being provided by Kayne Anderson Rudnick Investment Management, LLC (“KAR”) for illustrative purposes only. Information contained in this material is not intended by KAR to be interpreted as investment advice, a recommendation or solicitation to purchase securities, or a recommendation of a particular course of action and has not been updated since the date of the material, and KAR does not undertake to update the information presented should it change. This information is based on KAR’s opinions at the time of the recording of this material and are subject to change based on market activity. There is no guarantee that any forecasts made will come to pass. KAR makes no warranty as to the accuracy or reliability of the information contained herein.