Global capital markets kicked off Q2 on a positive note, with equity markets encouraged by gains in the US at the end of March. As vaccine rollout continues and brings with it an acceleration of the journey back to “normal,” we see numerous opportunities due to rapid economic expansion; especially in what appears to be undervalued cyclical sectors. We dive into these considerations in more detail below, with a keen eye toward the factors threading these key takeaways together.
Key Takeaways
In our view, market participants and analysts are still underestimating near term prospects for potentially rapid economic expansion and robust corporate earnings growth that may result from successful vaccination efforts, easing social distancing mandates, and downstream stimulus impulses (i.e. cash sitting in the bank from recent stimulus checks). As such, we believe analyst earnings estimates and price targets may be revised higher over the coming quarters; events that have historically proven to be some of the most potent catalysts for driving stock prices higher.
Given this possible disconnect between market expectations and reality, we expect the rally in small cap, value, and cyclically oriented stocks to continue. These are the companies most vulnerable to negative Covid-19 shocks but favorably positioned to take advantage of a return to normalcy due to the cost controls implemented during the recession and disproportionate exposure to pent-up consumer demand.
Consistent with this theme, we believe there is a potentially attractive tactical opportunity to add exposure to energy stocks, where investors currently may be underweight. Historically, energy stocks have tended to perform well during economic recoveries and in inflationary environments. Furthermore, with much of the downside likely priced-in following years of excess capacity, poor price returns, and low growth macroeconomic backdrops, energy stocks are trading at attractive historical valuations and may be positioned to surprise to the upside as direct beneficiaries of a potentially synchronized global economic recovery.
Trade Details:
- Increasing our overweight to equities by 1%.
- Targeting exposure to cyclically sensitive assets that appear to have the most attractive risk/reward profiles in a recovery regime.
- Adding energy stocks on a tactical basis, seeking to benefit from oil and gas’ asymmetric exposure to accelerating economic growth prospects and historical efficacy as a hedge against oil supply shock-induced market drawdown risks.
- Trimming growth to add to value.
- Shortening duration by selling longer-term investment grade bonds and US treasuries and adding cyclicality through increasing exposure to “fallen angels” (i.e., investment grade bonds that have been downgraded to high yield).
