How Rotation Trades, Covid News Have Markets Spinning
(Bloomberg) -- Farmers rotate crops, and stock pickers rotate sectors. It’s a time-tested technique that, like so much else, has been upended repeatedly as the coronavirus pandemic continues to dominate financial markets. That’s been compounded recently by the alternating torrents of good news about prospective vaccines and bad news about soaring case counts in the U.S. and elsewhere. Attempts by investors to position themselves for both a new dawn and the end of days has left many heads spinning, among market pros and retail traders alike.
1. What’s a rotation trade?
It typically refers to investors or money managers reallocating funds from one market sector into another, or one investment style into another. Such decisions could be based on expectations for the next phase of the economic cycle -- for example, fund managers who foresee growth might shift part of their portfolio into shares of companies in sectors like materials and financials, where performance is closely tied to the economy’s performance. When they expect a downturn, they might rotate into so-called defensive sectors, such as utilities or consumer staples.
2. What other kinds of rotations are there?
Investors may also rotate between strategies, such as value and growth. Value investing attempts to identify stocks that look cheap relative to a company’s fundamentals, while growth investing focuses on companies that have repeatedly posted better-than-anticipated earnings and are expected to keep doing so. Growth stocks tend to be more expensive than the broader market, while value shares are less costly.
3. How well does that work?
Like anything in life or in investing, it depends on your timing. The current rotation into value stocks is paying off handsomely -- the Russell 1000 Value Index posted its best month on record in November, and outperformed the Russell 1000 Growth Index for a third consecutive month. However, value diehards have taken a beating over a longer time horizon. The Russell value gauge is still down about 1% for the year, while its growth counterpart has gained over 32% in 2020. On a five-year basis, it’s still trailing by over 90 percentage points.
4. What has the pandemic meant for rotations?
The spread of coronavirus and the ensuing turmoil fueled a furious rotation into megacap tech companies with strong balance sheets and in position to profit from the work-from-home economy. That boosted the popular group of tech stocks known as the FAANGs -- Facebook, Amazon, Apple, Netflix and Alphabet Inc.’s Google -- dragging the Nasdaq 100 higher by over 78% since late March. Pandemic moonshots such as Zoom Video Communications Inc. and Peloton Interactive Inc. surged over 500% and over 300% year-to-date, respectively. Since the March lows, it’s been tough sledding for anyone placing bets on companies that win in a return to normal. That changed abruptly last month.
5. What’s changed?
November’s flurry of positive vaccine news set off a new rotation, out of big tech and into small-cap companies. Hopes that a broadly distributed treatment will lead to an economic reopening breathed life into areas of the market that had been crushed by the virus, such as energy stocks and those companies with weaker sheets. It also drove demand for cruise operators, hotels, travel companies and concert promoters. Breakthrough results from Pfizer Inc.’s and BioNTech SE’s Covid-19 vaccine trial on Nov. 9 boosted S&P value stocks to their best week of gains versus S&P growth stocks since 2008. Meanwhile, the Russell 2000 Index of small-cap stocks surged 18% in November for its best month on record.
6. What about the virus?
The vaccine is a hopeful sign but the winter is looking increasingly grim, as case counts surge and cities reimpose containment measures. The November job numbers also fell short of expectations, suggesting that the labor market’s recovery may have stalled. It’s entirely possible that a swath of small- and mid-sized businesses that could do quite well after a vaccine brings life closer to normal might not survive long enough to see that rebirth. However, back-and-forth stimulus negotiations resuscitated small-cap and value shares after signs of compromise in Washington emerged.
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