The Covid news is bad, with more flare-ups in the South and Southwest, bringing the added economic danger of more lock-downs. In the midst of this, the stock market continues to advance. That seems counter-intuitive, to say the least. Well, it’s the tech stocks, which are quintessential growth vehicles, that are powering the rise.
Nicholas Atkeson and Andrew Houghton, the founders of Delta Investment Management in San Francisco, argue that tech names also are the new defensive stocks. Say what?
Larry Light: The epidemic is at the center of everything, it seems. But now it has benefited tech stocks?
Nick Atkeson: Covid-19 is a major driver of trading activity since February. At the start of the crisis, the obvious projection was to say an economic shut-down would severely curtail economic activity and the equity market would suffer. For the first month, this is what happened. The S&P 500 declined by about 35% from late February into March.
Today, it appears there is a surge of Covid-19 cases in the U.S., which might cause investors to think we will see a repeat of the dramatic market sell-off that we experienced in March. This scenario is possible but it appears there is a flight to safety that is driving unexpected outcomes.
Light: Investment dollars certainly have gone into the typical refuges.
Andrew Houghton: Historically, when investors are worried, they migrate money into safe assets. One of the safest assets is U.S. Treasury bonds. With the collapse in interest rates and flight to safety, it is not a surprise that 20-year U.S. Treasuries have appreciated by about 24% year-to-date.
The Federal Reserve has injected trillions of dollars of liquidity into the markets. It is not a surprise that this causes investors to fear U.S. dollar devaluation and fund flows into gold. The gold ETF, SPDR Gold Shares, is up roughly 18% year to-to-date.
Light: What about the unexpected part?
Atkeson: Gold and Treasuries often appreciate during periods of elevated uncertainty. What is unexpected is the magnitude of Covid-driven fund flows in the equity markets. Companies that perform well in a virtual environment, have lots of cash and offer essential services are doing very well. That describes Apple AAPL +1.7%, Microsoft MSFT +0.2%, Amazon AMZN +0.8%, Google and many of the other largest companies of the Nasdaq NDAQ +1%. The Nasdaq 100 ETF, known as the QQQ, is up over 20% year-to-date. In some sense, this represents a flight to safety in a Covid-19 equity market.
By contrast, the equally weighted S&P 500 ETF is down by about 12% year-to-date. Covid-19 is driving fund flows out of cyclical, capital intensive, leveraged, in-person service-based traditional economy companies. Because the large capitalization technology stocks dominate the major stock market indexes, the overall effect is the S&P 500 is down marginally year-to-date even though the majority of stocks are down on the year.
Light: Amazing. The defensive stocks used to be utilities, health care, consume staples. Now it’s the FAANGS and their ilk.
Houghton: The take-away is: Just because we are seeing a surge in Covid-19 cases in the U.S., the stock market may not necessarily depreciate materially. In fact, if COVID-19 keeps driving funds into the largest technology stocks, which dominate the major market indexes, we could see index appreciation in an expanded pandemic environment.
Light: What happens if the epidemic goes into retreat?
Atkeson: The ideal market outcome during the second half of the year would be to have a major breakthrough on Covid-19 vaccination or treatment or both. This would allow the average stock to potentially close the performance gap with the Covid-19 winning stocks.
Many average stocks are trading at attractive valuations, particularly relative to the day the crisis abates. Maintaining a diversified equity exposure in this fast-moving Covid-19 environment remains a prudent approach.