With the boom nearing its peak, the booming reopening trade is threatened
Anything moves faster in a stimulus-crazed economy. The recovery occurred faster than anticipated, the rally in reopening stocks was dizzying, and now the comedown may arrive earlier than expected as well.
Stocks that have soared are beginning to recoup their losses in fits and starts. The small cap Russell 2000 Index – which was up 135 percent at one point after the pandemic’s low – is underperforming the Nasdaq 100 by approximately four percentage points this month, after largely dominating since November’s vaccine breakthroughs. In the last month, cyclical sectors such as financials and electricity have lagged behind technology.
Morgan Stanley warns that the economic cycle will be “significantly hotter and quicker” than normal. With growing consensus that growth will peak this quarter, the reopening trade that has fueled rallies in everything from cruise lines to casinos may also peak.
“It is time for investors to exit many of the strategies and sectors that perform well in the early cycle following a recession and into stuff that perform well in the mid-cycle,” Andrew Sheets, Morgan Stanley’s chief cross-asset strategist, said in a Bloomberg TV interview.
To be sure, the reopening trade is not dead, as illustrated Friday by a 2% rally in small caps and a leap in banks. However, investors are increasingly moving away from companies that profit from a booming economy and toward those that perform well under most circumstances.
The performance of exchange-traded funds reflects this sentiment. Bloomberg Intelligence data show that quality ETFs – which invest in companies based on their balance sheets and earnings – have absorbed $233 million so far in April, putting them on track for their first month of inflows since November. Meanwhile, large-cap equity funds received $7.8 million this month, compared to $336 million in outflows from small-cap ETFs – the first net outflow since September.
According to Goldman Sachs economists, the US economy will expand at a 10.5 percent annualized pace this quarter before slowing to 1.5 percent by the end of 2022. Although the economy is expected to grow faster than average in the second half of the year, defensive sectors such as utilities are expected to gain as the speed of growth slows, they said.
“Typically, decelerating economic growth is followed by sector rotations within the stock market,” Goldman strategists Ben Snider and David Kostin wrote this week in a note. “Cyclical industries usually outperform the market during periods of favorable and accelerating economic growth, but more conservative industries typically outperform during periods of peaking and decelerating economic growth.” relates to With the boom nearing its peak, the booming reopening trade is threatened.
Of course, if the US economy grows at an average of 7% in the second half of 2021, as Goldman anticipates, this does not necessarily spell the end of value and small cap stocks. For instance, financial stocks – one of the most heavily weighted sectors in value indices – appear to correlate closely with the shape of the US yield curve, which is typically expected to steepen through the end of the year.
However, after a ferocious rally, John Hancock Investment Management expects those reopening trades to cool. Over the last six months, the Russell 2000 has risen 38 percent, almost double the returns of the S&P 500 and Nasdaq 100.
“We’re still at the tail end of the early part of the cycle, and you’re seeing value begin to perform well,” Emily Roland, the firm’s co-chief investment strategist, told Bloomberg Television earlier this month. “We want to be in a place where we’re preparing for the mid-cycle period when fundamentals become even more important.”