So far this year has been a market of “V’s”. The largest, naturally, is the COVID-19 Virus, which brought an abrupt end to an 11-year bull market. The rapid market declines in March were followed by a similarly rapid rally, with headlines touting “V-shaped” recoveries ranging from stocks to jobs to new virus cases.
Moving into summer, Volatility continued, with swift but short-lived market pullbacks in June causing some hiccups in an otherwise steady march higher for equities. Now, to begin September, the market is experiencing another pullback of unknown depth and duration.
Facing heightened uncertainty and ever-changing market sentiment, we are focusing on what may be one of the most important “V’s”: Valuation. As uncertainty fades, valuations may be the “starting block” to where markets can go as a longer-term economic recovery unfolds.
Last week within our Active Suite of multi-asset portfolios, we shifted from Underweight to Neutral weight in equities following recent declines. Our re-entry was into Utilities, a historically defensive sector offering what we consider an attractive dividend yield, as we remain on guard to several near-term uncertainties. Despite the market pullback, valuations remain above historic averages, indicating three potential factors that may be at play:
1) Earnings and economic estimates may prove too conservative.
After a deep decline at the onset of the COVID-19 pandemic, earnings estimates may potentially “grow into” higher valuations. Corporate earnings have been generally better than feared. Additionally, economic and health indicators have largely trended in a positive direction.
2) Elevated valuations may be here to stay.
The market gains since the March low were driven largely by the high-growth, high-valuation Tech sector, which now comprises more than a quarter of the market capitalization of the S&P 500. At a time when digital technologies are revolutionizing many aspects of life and businesses must adapt to a new, more online product and employee environment, we think Tech’s strong earnings growth prospects may warrant above-average valuations. Just as important, low-interest-rate environments are usually accompanied by above-average equity valuations, and ultra-low rates seem likely to persist for a long time.
Tech outperformance continues
S&P Information Technology sector vs. S&P 500 performance, 2010–present
