The Value Tide is

RISING

We have emphatically stated that the companies that lead the market out of the COVID recession will not be the companies to take the markets to new highs. And thus far, we’ve been spot-on.

Jeff Powell | Managing Partner, CIO Tweet

2020’s stock market performance was dominated by “growth” companies. We all learned about new companies like Zoom and Teledoc and watched their stock prices, along with more seasoned companies like Amazon, Logitech, Apple, and Microsoft skyrocket during our “work from home / shelter-in-place” economy.

But like all good things, trends end. We began seeing “value” oriented companies start to take leadership of the market’s performance during the fourth quarter.

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As we came to the end of 2020, we firmly placed a stake in the ground and stated that the market leadership was shifting from “growth” oriented stocks (companies that don’t pay dividends) to “value” oriented stocks (companies that reward their investors by sharing their profits in the form of a dividend). We have emphatically stated that the companies that lead the market out of the COVID recession will not be the companies to take the markets to new highs. And thus far, we’ve been spot-on.

Q4 2020 Performance Chart

Value Should Continue to Outperform Growth

As we have written about extensively, the markets tend to move in trends. There are secular bulls (when the markets generally trend up), secular bears (when the markets go down as much as they go up), but there are also trends where a different type of investing is in favor. The chart below does a great job illustrating these trends.
When the line is going down, as indicated with the golden arrow, growth is doing better than value (and thus becoming more expensive). When the line is going up, as indicated with the green arrow, value is doing better than growth. Our chart starts off showing how growth was doing much better than value during the late 90s, which we affectionately call the dot-com era. When that bubble burst, value stocks did much better than growth from 2000 to 2003. The next four years saw a lack of leadership between the two. Both value and growth did well during this time period at about the same level.
The Great Recession saw a resurgence of value dominating growth, followed by a short growth spurt, and then a tug-of-war between the two from 2009 to 2016. Over the past four years, however, growth has dominated value. Investors have become complacent and lazy, thinking that they can just stick with their technology stocks and everything will be fine. We haven’t seen growth this expensive to value since the dot-com bubble burst (the red line).
Value vs. Growth Relative Valuations

A reference to the dot-com era often infers another technology stock bubble bursting. I don’t believe this will happen. Most technology stocks are far healthier, with positive earnings and solid cash reserves. I just think they are expensive. Their stock prices have run up too much. I can’t justify their current prices, based upon historical norms. This means that growth stocks will see less, if any, significant price appreciation until their earnings can catch up with the previous price appreciation.

It is our belief that you will see value continue to outperform growth for the rest of 2021 and possibly for several years to come. As you’ve seen from the chart, these types of trends take years to fully play themselves out.

Linear regression research, based upon logarithm of historical earnings-per-share data, further suggests that our belief will become a reality. The chart below shows large-cap growth (in blue) and large-cap value (in red) price movements compared to their historic linear regression rates (the dashed lines). Large-cap growth is 13.05% overvalued to where it should be today, and 8.71% overvalued to where it should be at the end of February 2022.

Large-Cap Growth Equity Series Earnings Per Share
Large-Cap Value Equity Series Earnings Per Share

We See Significant Upside Potential!!!

There is an old Wall Street adage that says, “Bull markets climb a wall of worry!” It doesn’t help that today we are fed news twenty-four hours a day, seven days a week. These news cycles need to be filled, and often prey on two subject matters: fear and greed. Right now, the worry “du jour” is inflation. We’ve seen the 10-year treasury go from 0.93% to 1.64% in two and a half months. If you remember, there is an inverted relationship between a bond’s price and its yield. In order to have had the yield spike this much, you’ve had to have seen a significant in bond prices. This means a far greater number of sellers than buyers.

We’ve been warning investors away from the bond market for a long time. Why would you want to lock in a ten-year investment in something that you know will lose you money? At the beginning of the year, our Consumer Price Index (CPI), which measures inflation, was at 1.4%. An investor of a ten-year treasury was saying they were comfortable losing ½% of buying power per year for ten years. This is also known as the “real yield.” Even now, CPI has crept up to 1.7%. Why would you invest in any investment that guaranteed you absolutely no return, if you held it for the full ten-year duration? We don’t see this most recent price action as anything that should derail the current upward trend in our investments.

After experiencing the greatest quarterly drop in GDP U.S. history during the second quarter of 2020, the U.S. economy has
stabilized due to multiple government stimulus initiatives. 2021 is projected to be stronger than any time in the past five years
and substantially higher than GDP growth post great-recession.

We are also projecting that 2021 will be a record-breaking year for Standard & Poor’s companies, as seen in the graph below. On the right side of the chart, you will see three light blue bars in a bar graph. These three light blue bars are the estimated earnings for the S&P 500 for 2020, 2021, and 2022 (left to right on the chart). 2020 earnings are still considered as an estimate because the 4th quarter gets reported in Q1 of the following year. So, we are still waiting on some companies to report their Q4 earnings.

That said, it’s obvious why 2020 is substantially lower than 2019, given the worldwide pandemic. Analysts are predicting a substantial comeback in corporate earnings in 2021 and in 2022. This is largely based upon an opening up of the U.S. economy as we come closer to having herd immunity over COVID-19. An investor must be cautious, however, and understand which sectors are expected to see substantial earnings growth

S&P 500 Earnings Per Share

During the first two months of 2021, the S&P 500 has continued its upward trends, with value companies leading the way. Energy and Financials have performed the strongest, after both sectors experienced negative returns in 2020. 

One thing that Polaris Wealth was looking at going into 2021 was the twelve-month earnings growth rate estimate (highlighted below – NTM stands for next twelve months) for each sector. As you can see, as pointed out by the green arrows, four of the five sectors highlighted are expecting well over 20% earnings growth, with industrials at almost 80% growth rates. While we are not fond of the energy sector in the long-term, we see substantial short-term upside, as people use more fossil fuels to get back to work.

We are not suggesting that an investor should abandon the six other sectors that are not highlighted. The information technology sector, for example, represents 27.4% of the S&P 500. It would be potential financial suicide to not have some exposure to this important part of the market. We’d rather see a clinical and disciplined approach to finding the best opportunities for price appreciation, rather than sitting in investments that are known to be overvalued. For example, real estate is expensive as a sector and is expecting below average earnings growth. There are still companies in the Real Estate sector that look like good opportunities, but as a whole, this is an area of the markets that we would avoid.

S&P 500’s Sector Detail • As of 2/28/2021

Conclusion

We expect 2021 to be a stock picker’s market. There is definitely opportunity in sectors of the market that are not projected to see strong growth. There are also “land mines” that can occur by purely buying dividend-paying stocks in the sectors predicted to see the best growth.

Polaris Wealth successfully navigated the year 2020: A year that can only be called the most challenging market in almost a century. All eight stock strategies we ran outperformed their like benchmark and did so with less risk. 2021 trends have continued. Polaris Wealth’s strategies are off to an amazing start in 2021. Again, all of our equity strategies are handily outperforming their benchmarks.

If you are sitting on too much cash, please call us and get it working for you. We see continued opportunity for you in the investments we are making and think getting cash working right now makes complete sense. We aren’t buying the stock market or an index; we are investing in a select group of companies that we believe have a strong probability of appreciating in value this year.

If you are unhappy with how some of your non-Polaris investments are performing, please let us provide you with a “second opinion” on those investments. As you know, we are a fiduciary. We will provide you with the most honest opinion about what to do with these investments.