Using a barbell to strengthen your equity portfolio

by Antonio (Tony) DeSpirito, Managing Director, Chief Investment Officer, U.S. Fundamental Equities, Blackrock, Inc.

Cyclically oriented value stocks could make a comeback in 2021, yet there’s still a place for durable growers in a balanced equity portfolio. Tony DeSpirito, CIO of U.S. Fundamental Equities, explains.

Among our top calls for the new year is the potential for beaten-down value stocks to surge back in 2021. Yet we wouldn’t count out some of 2020’s big winners those growth companies with dominant and emerging business models that can continue to meet or exceed lofty shareholder expectations. We believe an approach that barbells the two can strengthen equity portfolios.

The case for a value resurgence

Investors weren’t necessarily seeking low valuations in 2020. Growth stocks supercharged by low interest rates, digitization, work from home and other pandemic-related trends were continuously bid up and led the market higher. It wasn’t until November, with positive vaccine news and election relief, that value took the mantle – and we think it can hang onto it.

We don’t count growth stocks out, yet we see a near-term opportunity for value investors for a few key reasons:

1. Room for a bigger bounce. Some growth businesses may be permanently accelerated by COVID, but for others, the 2020 bump was a temporary pull-forward of demand. Meanwhile, cyclical value stocks, those with ties to economic growth and low valuations, have been most depressed and should enjoy a larger bounce with market and economic recoveries. A look back also shows that value historically has outperformed in the early stages of a recovery.
2. The return of buybacks. Company buybacks of shares slowed dramatically in 2020. We believe activity should resume in 2021. Having that incremental buyer in the market pushes stock prices up and is good for the market overall. But buybacks are more accretive for value stocks, as buying shares at lower valuations (removing them from the market) has a greater proportionate impact on the value of the remaining shares.
3. Easier year-over-year comparisons. Corporate earnings comparisons could matter more in 2021. Many value cyclicals will have an easier time beating dismal 2020 figures versus growth companies with a much higher bar to pass to impress investors.

A key role for growth stocks

Notwithstanding our outlook for a value resurgence, we see good reason to stick with stocks with dominant and emerging business models that can continue to deliver for shareholders. Sectors like technology and healthcare contain many high-quality businesses with the ability to compound growth across time.

Overall, we favor a barbell strategy to balance the “tried and true” structural growers with more opportunistic positions in cyclical stocks that could benefit as the economy heals. We see active stock selection as the best route to uncovering opportunities in both categories, particularly as COVID-19 impacts will need to be evaluated on a company-by-company basis. I expand on this idea in a recent episode of The Bid podcast, A stock picker’s guide to 2021.

An opening for dividends

Another type of grower we like: dividend growers.

Dividend cuts scared many investors away from equity-income strategies in 2020. We’re passed that now. Our analysis shows S&P 500 dividend cuts peaked in May and have since stabilized. We expect dividend growth to resume in 2021 as vaccine distribution and greater clarity in general give company managements the confidence to release excess cash in the form of dividends and buybacks.

With interest rates around the world set to stay low for longer, company dividends are likely to provide better income than bonds for some time. In addition, companies can  and many often do  increase their dividends whereas bond coupons are fixed to maturity. Dividend growth that compounds over time is a compelling proposition in an environment of generation-low U.S. Treasury yields.

Dividend benefit compounds across time
U.S. equity sources of return, 2020 and longer term

Source: BlackRock, with data from Refinitiv Datastream and MSCI, through Dec. 7, 2020. The chart shows the breakdown of return for year-to-date and trailing five and 20 years, annualized, for the MSCI U.S. Index. Earnings reflect changes in 12-month forward IBES earnings estimates. Multiple expansion depicts the change in the 12-month forward price-to-earnings ratio. Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.

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