As the economy reopens, cyclical value stocks are starting to perform a lot better. Remember, that what we experienced was something that has never happened before, with the major economies across the globe shutting down due to a virus. I’d suggest the lock-down was more like the black swan rather than the pandemic, which are inevitable, but thankfully infrequent. The lock-down put enormous pressure on just about every company, municipality, and individual to figure out how they are impacted and how to best manage it. Of course the stock market reacted very poorly to this disaster, with the quickest and deepest short-term bear market in history. This was far worse than 1987 and was even more rapid than 1929 and 2008, but it didn’t go as deep as after the largest crashes.
When the market bottomed in late March, it was the leading tech and healthcare stocks that led the way. Going into the bear market, growth traded at one of the widest spreads to value in history. After the bottom, the difference grew to the greatest spread ever, creating one of the best relative opportunities to buy value stocks cheap. It was the haves vs the have-not’s. Stocks like Amazon, Facebook, Alphabet, and Microsoft could seemingly elevate to nearly any price. Other companies such as AT&T, Bank of America, Wells Fargo, and Altria, were priced extremely pessimistically.
This trend has started to change over the last few weeks, and we’ve seen value stocks start to take off with big moves in financials and energy. The bear market allowed us to improve the quality of our positions and add materially at lower prices via stock purchases and cash-secured put sales. I’m very optimistic that as our options expire over the next seven months, we are likely to be in really good shape. I’ve always said that you don’t see the full benefit of the strategy until you see options expire, because time and volatility play a critical role in what we do. This was a nasty bear market, but we have owned good companies at great prices, which should lead to good results and I’m confident we are on the right path. We just need to let it play out.
Barron’s had an interesting quote by Jim Paulsen, which kind of summarizes where things stand in the market.
“While the most-expensive stocks have gotten far more expensive–the average valuation has risen from 26.3 times to 38.3 times–the average for the remainder of the market hasn’t changed much. It’s 14.5 times versus 13.2 times. The takeaway: “The broad market is not overvalued,” Paulsen says.
I don’t think the overall market is a bargain, but many cyclical stocks are still really cheap. Warren Buffett once said that even in a low interest rate environment, a bank like J.P. Morgan should trade at 2-3 times book value, based on its return on equity. Many market pundits have been bearish during this rally. I think they missed a few key things. Firstly, the data on the virus is a lot better than what was initially anticipated. Secondly, we have never seen global fiscal stimulus as large as this and so quickly, and the Central Banks’ have been very aggressive. Thirdly, with interest rates so low, equities should trade at higher valuations than they do currently. Lastly, I’d suggest many don’t seem to realize that many of the unemployed are actually making more than they did when they were employed, due to the increased benefit payouts.
It has been a tough year in so many ways, for so many. We are making progress though and things are getting better. Jamie Dimon recently suggested that the big banks might be done adding reserves after the 2nd quarter. Friday’s blockbuster jobs report, which shocked the world, provides further good news. We could be at the beginning of a major multi-year run for value stocks, and if that is the case we are well-positioned to capitalize.