Investors pile into stocks that win in a full economic recovery

Signs are multiplying in the stock market that investors see the recovery from the coronavirus taking hold.

Rising optimism in the economy is popping up everywhere, with shares of banks and energy companies and small firms soaring. At the same time, previous market winners that stood to benefit from stay-at-home measures are turning into laggards. Cruise lines soared, while Peloton and Zoom Video have started lagging behind.

The reversal is across industries and market-cap, with more economically sensitive shares and small firms soaring. At the same time, previous market winners that stood to benefit from stay-at-home measures are turning into laggards. The small-cap Russell 2000 surged 3.1 per cent Wednesday, while tech-heavy Nasdaq indexes needed a late-session rally to close in the green.

Behind it all is a belief that as states and countries reopen and the coronavirus curve slowly flattens, investors are free to position for a monumental shift. Nowhere was that more visible than in price action of walloped industries like airlines and cruise operators. Carnival Corp. and United Airlines Inc., both up more than 12 per cent Tuesday, again gained near 4 per cent or more.

“If people believe the economy is starting to bottom out, they are starting to look at those more cyclical areas,” Wayne Wicker, chief investment officer of Vantagepoint Investment Advisers, said by phone. “The biggest catalyst for that is the opening of some of these economies that are giving encouragement that America is going to go back to work.”

A Dow Jones market neutral index of value stocks that goes long the cheapest stocks and shorts growth shares notched its best day in at least 18 years Tuesday, while styles including momentum stumbled. The sharp rotation was on display again Wednesday, and is raising hopes for a turn in the 10-year trouncing the buy-low philosophy has endured.

The Russell 1000 Value Index rose 2.1 per cent Wednesday, beating its growth counterpart by 1.5 percentage points. The divergence was evident at the stock benchmark level too, the Dow Jones Industrial Average up 2.2 per cent while the tech-heavy Nasdaq rose just 0.6 per cent.

“The sweet spot for a risk-on rotation is now, as economies reopen and more fiscal programs are implemented,” said Dennis DeBusschere, a strategist at Evercore ISI. “The quant ‘arms race’ has helped create an investment landscape where assets optimize to new regimes and narratives rapidly.”

Strategists at Wells Fargo Securities including Chris Harvey and Anna Han went “all in” on value stocks in early April, in part due to “historic price dislocations.” Now that the trade is in motion, they’re taking what they call “the next natural step” -- upgrading their call on small-cap stocks to overweight versus large-cap peers, the strategists wrote to clients Wednesday.

Goldman Sachs Group Inc. is latching on to risk, albeit a bit more apprehensively. Analysts including Alessio Rizzi note that sentiment and positioning measures remain somewhat bearish, even as the risk recovery continues. That leaves some investors worried about the potential for a massive rotation, and the possibility of being left behind if an economic recovery proceeds smoothly.

“The risk of rotation frustration increases as markets turn more bullish on growth - as a result, we only position selectively in reflationary, procyclical trade ideas,” the analysts wrote in a May 27 report. “The growth recovery might be bumpy due to risk of second COVID-19 waves and potential second-round effects from the lockdown, such as a pick-up in bankruptcies, defaults and a continued weak labor market.”

Cantor Fitzgerald’s Sachin Raghavan also noted the shifting equity market sands, pointing to outperformance of value stocks, as well as banks, transports and airlines, which stand to benefit from a normalization of economic activity. He expects the trend to continue, but with one large caveat:

“Unless there is a significant resurgence in COVID-19 cases in major cities across the country.”