by Antonio (Tony) DeSpirito, Managing Director, Chief Investment Officer, U.S. Fundamental Equities, Blackrock
Embracing the bright side. So far 2021 isn’t looking too different from where we ended 2020. But we see the second quarter bringing greater economic re-awakening, underpinning our constructive outlook for U.S. stocks. What do we see for Q2?
- Economically sensitive stocks continue to lead.
- An opportunity to boost value positions.
- Bouts of volatility sparked by rate movement.
Market overview and outlook
Stocks encountered volatility but powered ahead in the first quarter. Cyclical stocks – those sensitive to economic momentum continued to lead, building on outperformance that began with positive vaccine news in November of last year. We see their strength continuing in the second quarter as economic signals point positive. The key propellants: a new $1.9 trillion fiscal package, continued monetary policy support, an uptick in vaccine supply and distribution, and ample corporate and consumer cash waiting to be deployed. We think it makes sense to position for the start of a new and powerful economic cycle – while watching for signs of a downshift once the post-COVID bounce begins a transition to trend growth.
“The U.S. economy is being fueled on multiple fronts, making it very hard not to like cyclical stocks right now.”
What to watch in Q2
1. Interest rates
Recent spikes in bond yields incited mini taper tantrums in stocks, moderate versions of the 2013 market retreat when yields soared after the Fed hinted at a pullback in easy policy. Stocks may continue to react to rate moves, as low yields on bonds are a key contributing factor to the relative attractiveness of equities. Rising rates can undermine support for equity valuations.
Importantly, however, today’s Fed is not contemplating near-term tightening, as it was in 2013, and interest rates are still very low on a historical basis. While future rate-related panics are likely, we expect rates to remain low for some time as central banks globally look to maintain support and see economies to full recovery. Ultimately, rates may only return to the average seen following the 2008 GFC, as we see no real structural changes in the economy that would suggest a growth trajectory far different from where we began. This is still a level that we would view as supportive of stocks.
2. Vaccine progress
Markets are priced for positive vaccine news, and while positivity is our base case, any disappointments in vaccine supply, distribution or adoption or increased risk from virus variants could stoke volatility.
The Biden administration has indicated the U.S. will have enough vaccines for all adults by the end of May. Our analysis of data from the three major vaccine makers suggests this is entirely feasible. Efficacy data shows the current vaccines are effective in preventing severe disease and hospitalizations, which is what is needed for economic re-opening. The variants are perhaps the biggest risk to the restart, yet clinical data has shown current vaccines demonstrate sufficient efficacy against the known mutations – enough to provide immunity and alleviate hospitalizations.
In addition, the technology used to make the vaccines means formulas can be quickly adapted. The major vaccine makers are ready with boosters once initial doses are administered. All of this gives us confidence that vaccination programs will continue to do the hard work of combatting the virus and facilitating economic and market recoveries.
3. Company earnings
Fourth-quarter earnings strongly beat consensus analyst estimates as well as what was mostly conservative company guidance. We generally see the pattern continuing this year. Though that should be good for the stock market broadly, we don’t expect real clarity on the earnings picture until the third- or fourth-quarter earnings seasons.
Economically sensitive sectors and stocks have the most potential to surprise to the upside, easily beating dismal prior year earnings. This is reflected in the earnings momentum chart below, which gives energy, materials and financials an edge. Growth companies that excelled in 2020 will find it much harder to exceed prior-year levels.
Many of the so-called stable sectors that did well in 2020 have poorer earnings momentum. Mega-cap technology stocks, long bastions of stability, also bore the brunt of the recent rates-related pain. Because these large tech stocks are long duration in their cash flow and growth prospects, they reap the greatest benefits from low rates and, in turn, have gotten hurt most as rates normalize upward.
We give cyclical stocks and reopening plays in general the advantage for the moment, while remaining watchful for signs of a cycle transition as the recovery moves forward potentially returning the upper hand to growers.
We believe fundamental active investing can offer an advantage in this environment.
An earnings edge for cyclicals
Three-month change in analyst earnings estimates, March 2021
Source: Refinitiv Datastream, MSCI and BlackRock Investment Institute, as of March 2, 2021. Chart shows the percent change in analyst earnings estimates over the last three months for the representative MSCI World sector indexes. It is not possible to invest directly in an index.
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