Finding value in a post-pandemic recovery

by Stephen Bruce, Director, Portfolio Management / Head of Research

We have seen great successes with the COVID-19 vaccine, with three potential vaccines to come to market, a Biden presidency has renewed hope in the US as a global leader, and, closer to home, Australia’s economy and communities are reemerging from the longest lockdown in our history.

These good news stories have seen markets rally strongly, with a sharp rotation away from expensive growth stocks towards more traditional value stocks, due to value’s greater leverage to an improving economic outlook.

So, what do these developments mean for markets, investors, and the world at large? Will 2021 bring fresh hope for value?

A Biden Presidency, A Win For Value

A Biden Whitehouse combined with a Republican Senate is widely considered to be a “Goldilocks” outcome for markets. A Biden presidency is expected to see far more stable, predictable, and measured conduct of domestic and foreign policy. With business and markets enjoying certainty and predictability, a Biden presidency will rally the economy.

The likely Republican control of the Senate, however, will put a handbrake on any of the more ambitious policy changes, such as significant corporate tax increases, that Biden’s government hopes to pass. This “legislative gridlock” provides further stability, which is viewed favourably by markets.

Regarding fiscal settings, the Democrats’ inclination is to spend more, and it is likely there will be significant fiscal stimulus coming. This should be positive for near term growth, especially with interest rates likely to stay at historically low levels.

What Does This Mean For Investors?

The market is clearly looking forward with optimism to a more recognisable “Post-Trump, post-COVID” world. In this environment, normal activities resume, global growth rebounds, and we get back to something resembling business as usual. Combine this with historically low interest rates and fiscal stimulus and markets could continue to rally strongly.

There will however be important implications for the performance of different sectors of the market. Over recent years, weak economic growth and declining interest rates have seen growth stocks outperform strongly. The best example of this is in the US, where the rise in the S&P500 has been almost entirely attributable to the performance of a limited number of large tech stocks, while many other sectors have declined. The factors which drove the outperformance of growth stocks will now reverse, with economic growth rebounding strongly and interest rates rising from their current historically low levels.

History has shown rising interest rates and economic growth usually trigger a rotation out of growth stocks and into value stocks. In the Australian market, the end of every US recession in the last 40 years¹ has been followed by a period of outperformance by value stocks. November’s performance² was no exception, with value outperforming strongly.

Should conditions continue to normalise, this rotation to value may still have a long way to go, given the extreme valuation dispersion which has developed between different sectors of the market. The current level of valuation dispersion is even greater than at the height of the first tech boom back in the last 1990’s. There is likely to be ongoing mean reversion as earnings growth broadens out through the economy and the tech stocks, for example, come into the sights of regulators and politicians.

A Reason For Optimism

The pandemic has highlighted how critical it is for the global community to work effectively together. The COVID-19 crisis has brought into sharp relief the fragility of many international systems and the work needed to make them more robust.

Fortunately, it is likely the US will take steps to resume its leadership role on global issues from COVID-19, to climate change, and international relations, particularly the relationship with China, which is of critical importance to Australia.

The disruption from living in lockdown and working from home has led to an acceleration of digitisation, an increased level of flexibility, and new ways of doing things. This will speed up innovation, leading to better and more efficient ways of doing things going forward. The rapid uptake of telehealth is the perfect example. While the benefits this could bring in terms of accessibility, cost, and efficiency have been long known, it took the pandemic to really drive its implementation.

The pandemic has also brought an even sharper focus on the environment (with disease outbreaks being, in effect, an environmental risk). The post-pandemic stimulus measures in various countries are likely to include infrastructure investments which will drive a further acceleration in the energy transition away from fossil fuels.

These positive developments will help our global economy recover strongly from a year of historic disruption. While there will always be things to worry about, investors need to remember that, on the long view, the world has always improved and there’s plenty to be optimistic about right now.

ENDNOTES