A market rally despite the COVID-19 driven recession
Since the dramatic share market lows of March 2020, the market has rallied by over 30% (S&P 500 – US Share Market). The rally has developed despite the ongoing pandemic and the global recession that occurred as economies ground to a halt to try and contain the virus spread.
The share market rally is similar in size to what we saw after the 2008 Global Financial Crisis (GFC) but, when we compare to the current rally, we can see a big difference in the sectors that have driven it. The current rally has primarily been driven by technology stocks, which are usually classified as growth stocks, rather than the cheaper value stocks.
During the post GFC rally both growth and value stocks picked up, with the value stocks rallying a bit more than the growth stocks. The current rally has been overwhelmingly driven by growth stocks and, at the time of writing, these stocks are well above their pre-COVID-19 recession highs while value stocks are well below.
Before we delve in to see why the rally has been different this time, it’s important to understand the differences between growth and value stocks. The table below provides an explainer:
Over time you would expect that value stocks would outperform growth stocks emerging from a recession, but this hasn’t happened this time around.
What’s going on? Are growth stocks being ‘over valued’ by investors?
The very strong and consistent profitability of growth stocks, as measured by earnings per share (EPS) is clear. If we look at the timeframe of pre-GFC (March 2007) until today (September 2020) the predicted profitability (12-month forward looking EPS) of growth stocks is more than double the level of value stocks.
Usually when we try to work out if stocks are cheap or expensive, we use more traditional metrics such as the conventional ‘book’ valuations of earnings, sales and dividends. At the moment, US growth stocks are showing to be too expensive (by around 25%) according to these estimates. But there are also many ‘quality’ factors, such as stable and elevated company earnings, which mean growth stocks may be around fair value (neither cheap or expensive). If we look at other valuation methods, such as comparing to bond yields, valuations are at or below fair value for growth stocks.
What will happen now?
The current rally has taken us into unprecedented territory when we look at the magnitude and leadership of the recovery and finding out whether growth stocks are currently cheap or expensive is complex. What isn’t in any doubt is that the share market will continue to be supported as economies heal but, as always, some short-term setbacks are likely, particularly until an appropriate vaccine can be developed. In the meantime, a longer-term well-diversified strategy using different asset classes including cash, property and fixed income, may be a more prudent approach.
In this complex and everchanging landscape, quality financial advice is key. Your adviser can develop a plan to help you to prepare for your financial future and support to keep it on track.
This publication is issued by ‘OnePath’ (OnePath Funds Management Limited ABN 21 003 002 800 AFSL 238342 - OnePath Funds Management and OnePath Custodians Pty Limited ABN 12 008 508 496 AFSL 238346 RSE L0000673 – OnePath Custodians). This article contains general information and may also contain professional opinions which are given in good faith and based on information and assumptions believed to be reliable as at 24 August 2020. The author makes no representation as to its accuracy or completeness and the information should not be relied upon as such. Any opinions, estimates and forecasts herein reflect the authors’ judgments on the date of this publication and are subject to change without notice.
It does not take into account an individual’s personal needs, financial situation or objectives, requirements, personal needs or financial circumstances or tax position. Information does not contain and should not be relied upon as containing investment recommendations or advice and does not constitute an offer or an invitation to deal in, or a recommendation to acquire or sell any product or subscribe to any service.
OnePath Funds Management and OnePath Custodians are members of the IOOF group of companies, comprising IOOF Holdings Ltd (ABN 49 100 103 722) and its related bodies corporate. Neither OnePath Funds Management, OnePath Custodians nor any other related or associated company guarantee the repayment of capital, the performance of, or any rate of return of an investment with OnePath Funds Management or OnePath Custodians. An investment is subject to investment risk, including possibly delays in repayment and loss of income and principal invested. Past performance is not an indication of future performance.