Analysis Of The Uneven Rebound Amongst Different Industries
A wide range of stocks powered the November market rally, a first this year. The IWR, which tracks the Russell Small Cap Index is up 16.81% whilst the VIMSX, which tracks Mid Cap stocks is up 15% outperforming the QQQ in the same time period. The recent rally also lifted up the financial services sector – one that is particularly sensitive to economic data, with Bank of America (NYSE:BAC) and JP Morgan (NYSE:JPM) up 25% and 26% respectively. Pfizer’s vaccine’s highly promising efficacy served as a catalyst, giving investors hope that the pandemic and its far-reaching social and economic ramifications could soon unwind by spring.
With that, investors looked with optimism towards 2021, disregarding, unemployment, current death tolls and COVID-19 infection rates. In addition, the election played out in the best possible situation. Biden won the presidency, but not the Senate. Biden’s cabinet picks and the GOP Senate majority assured investors that the administration would follow a largely moderate platform without displaying overt hostility to Wall Street. It also allowed investors to ‘have their cake and eat it too’ in that in Biden they had beneficial foreign policy and a less erratic government; undesirable traits seen often in Trump and a Republican Senate ensuring a continuation of low corporate tax rates and deregulation.
With that, investors now look onto 2021, searching for sectors and companies with untapped potential and huge upside. However, to find such companies, first, an understanding of recovery forecasts is required.
A good way to understand why there is such a large discrepancy in the rebound experienced by different sectors is to draw a parallel with (bond) tranches. In a tranche, senior tranches contain debt with higher credit ratings than that of junior tranches. The senior tranches have first lien on the assets (they are paid first if there is default) whilst junior tranches have a second lien or no lien at all. Stocks at a higher ‘tranche’ are likely to rebound first followed by junior tranches. Similarly, a default is like a recession, economic contraction or sell off. Stocks known to ‘rebound’ well during such conditions (‘higher credit rating’), are more expensive (‘lower coupon rates’). It is crystal clear for most that FAANG and other tech companies make up the senior tranche but most are unsure of the ‘rankings’ of the other 10 sectors.
The following are the 11 commonly-recognized sectors:
1. Consumer Discretionary (Recovered June 18th/Up 35% YoY)*
2. Consumer Staples (Recovered Aug 7th/Up 8.48% YoY)*
3. Health Care (Recovered July 14th/ Up 13.65% YoY)*
4. Industrials (Recovered Nov 11th/ Up 11.83% YoY)**
5. Information Technology (Recovered June 5th / Up 46.24% YoY)
6. Materials (Recovered Aug 4th/ Up 21.85 % YoY)**
7. Real Estate (Has not recovered/ Down -2.79% YoY)*
8. Communication Services (Recovered Aug 4th / Up 24.38 % YoY)*
9. Utilities (Yet To Recover / Down 1.38% YoY)*
10. Financials (Yet To Recover / Down 2.83% YoY)*
11. Energy (Yet To Recover / Down 29.79% YoY)*
*Results are as of 4th December market close and sourced from the spglobal.com site.
Stocks are volatile, time sensitive securities and prices may swing drastically in sectors rendering abovementioned data inaccurate. As such, readers should use the hyperlinks to spglobal.com, or their preferred source to keep up to date on market data.
**These sectors experienced big returns in the beginning of 2020, right before March selloffs, therefor, YoY returns may prove misleading. Once again, readers should look at the sectors’ data.
(A) Looking at the ‘recovery’ data above, we can rank the sectors by market performance:
3. Health Care
4. Materials
7. Industrials
8. Utilities
9. Real Estate
10. Financials
11. Energy
(B) When ranked by YoY performance:
1. Information Technology
2. Consumer Discretionary
3. Communication Services
4. Materials
5. Health Care
6. Industrials
7. Consumer Staples
8. Utilities
9. Real Estate
10. Financials
11. Energy
As we can see from the data, IT expectedly topped out YoY, closely followed by Discretionary and Communication Services whilst Energy is still deep in the red.
Backtesting shows us that choosing a sector ranked higher on ‘recovery’ performance (refer to A), and lower on YoY (refer to B), can produce additional gains of up to 10%. Whilst, it may just be a coincidental correlation that does not imply any causation, it may be due to the fact that stocks that ‘recover’ quickly yet does not produce gains above (10% or more) the RSP (Invesco S&P500 Equal Weightage ETF), have higher ‘headroom’ till they reach their full earnings potential.
A perfect example of a sector with untapped potential is the Health Care sector as depicted by the chart below.
Source: spglobal.com
The S&P 500 Health Care Index constitutes of:
1. Johnson & Johnson (JNJ) +
2. United Health Group (UNH) +
3. Pfizer Inc (PFE) -
4. Merck & Co Inc (MRK) -
5. Abbott Labs (ABT) +
6. AbbVie Inc (ABBV) +-
7. Thermo Fisher Scientific (TMO) +-
8. Medtronic plc (MDT) +-
9. Danaher Corp (DHR) +-
10. Bristol-Myers Squibb (BMY) –
+ indicates consistent share price history growth
- indicates inconsistent share price history growth with sudden swings.
Out of the ten stocks listed above, we prefer UnitedHealth Grp (UNH) and Abbott Labs (ABT). As much as investors would like to believe that labs that find a highly effaceable COVID-19 vaccine will reap in gargantuan sums of money, this is simply not true.
The rationale behind this statement is multipronged. The first being that Big Pharma would like to dismantle Big Phrama or at least the negative connotations attached to their companies. “It doesn't really make sense to profit from this pandemic," said Tinglong Dai, associate professor of operations management and business analytics at Johns Hopkins University Carey Business School in Baltimore.
"This is a perfect time for [pharmaceutical companies] to develop their brand equity, which will serve them well for longer -term profits. In the long run, what's really important for pharmaceutical manufacturers is in brand equity. So people trust Pfizer, for example." [Source CBS.CA].
Such an approach has already been taken by some companies, such as Johnson & Johnson and AstraZeneca. JNJ which has lately been involved in an Opioid scandal, is sure to have taken their public image in consideration when they chose to temporarily mot profit from this. It would also not be a surprise if other vaccine makers choose against making a large profit in fear of being labeled as ‘price gougers’. No one wants to be the next Valiant.
Pfzier has announced that it will being selling vaccines at $19.5 and that it would be able to produce up to 1.3B shots by 2021.
Analyst Cinney Zhang of Bloomberg Intelligence estimated that Pfizer would be able to profit $7B from the vaccine. Whilst it may appear a huge sum, when compared to Pfizer’s annual $50B revenue, it doesn’t seem that big anymore. The $7B that BioNTech would receive however would have a bigger impact on bottom line once again emphasizing that midcap stocks have more to gain. Seemingly, companies poised to gain most from the vaccine are going to be financial services and energy companies. Ironic innit?
Finally, as with most stocks, profits expected from the sale of vaccines is already priced in and as such, potential upside now is minimal. UnitedHealth Group, one of the largest American insurers has its future safeguarded for the next few years given that Republicans have a majority in the Supreme Court and a majority in the Senate rendering the passing of a ‘radical’ Affordable Care Act that uses a single payer system improbable.
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