Markets are moving away from a 'Darwinistic' phase: Morning Brief

Tuesday, December 22, 2020

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Survival of the fittest should be a fading theme in 2021.

Here in the Morning Brief and on Yahoo Finance we’ve written a lot about various markets forecasts for 2021.

The Wall Street consensus says earnings should grow appreciably next year and stocks should continue to rise. The details might differ from firm to firm, but the broad outlines are nine-tenths the same.

And while Rich Bernstein, CEO and CIO at Richard Bernstein Advisors, isn’t exactly zigging while the rest of the Street is zagging, we found his outlook offered a unique and helpful thematic frame on what the year and economic cycle ahead could have in store.

As Rich puts it to his clients: “Embrace the profits cycle.”

And the profits cycle tells you that as regimes change, what had been working tends to stop working while areas of the market that hadn’t been working should start finding a bid. Everything old is eventually new again.

“The direction of the overall stock market in 2021 could be very misleading and could mask a significant shift in underlying market leadership,” Bernstein writes. “In other words, the stock market might do well or not, but the potential for a major shift in market leadership could present significant investment opportunities.”

Because while the pandemic and resulting economic fallout brought financial markets and the global economy to its knees, let us not forget the dynamics that were driving markets at the end of the last decade. Narrowing leadership amid a slowing profit cycle — which means market gains were driven by rising valuations not rising profits — helped fuel the first group of companies to attain market capitalizations north of $1 trillion.

The FAAMG stocks became the hot trade at the end of the last decade not because the acronym was catchy but because Facebook (FB), Apple (AAPL), Amazon (AMZN), Microsoft (MSFT), and Alphabet (GOOGL) were the companies with the strongest earnings growth.

“When profits cycles decelerate, markets become ‘Darwinistic’ and survival of the fittest determines stock performance,” Bernstein writes. “Fewer and fewer companies can maintain their earnings growth as overall economic conditions worsen and investors gravitate toward a smaller universe of growing companies and bid up those companies’ valuations. Simply put, the price of earnings growth appreciates as growth itself becomes increasingly scarce.”

But with the economy coming out of recession, a new cycle of economic and profit growth begins. For Bernstein, this mean the trades that had fallen out of favor with investors should benefit next year while the sectors that had been most loved could take a step back.

And so in this case, big cap tech stocks could be shunned by investors like financials (XLF) and materials (XLB) enjoy the early stages of an economic upturn.

“The biggest story for 2021 might not be ‘the market,’ but rather a significant shift in market leadership and sector, style, and size performance that is currently unimaginable to many investors,” Bernstein writes.

“Innovation, disruption, intangible assets, and long time-horizon investing could give way to ugly cyclicals, unknown small caps, downtrodden value, real assets, and investors’ demand for immediate strong earnings growth.”

By Myles Udland, reporter and anchor for Yahoo Finance Live. Follow him at @MylesUdland

What to watch today

Economy

  • 8:30 a.m. ET: GDP annualized quarter-over-quarter, 3Q third revision (33.1% expected, 33.1% in prior print)

  • 8:30 a.m. ET: Personal consumption, 3Q third revision (40.6% in prior print)

  • 8:30 a.m. ET: GDP price index, 3Q third revision (3.6% expected, 3.6% in prior print)

  • 8:30 a.m. ET: Core personal consumption expenditures, 3Q third revision (3.5% in prior print)

  • 10:00 a.m. ET: Conference Board Consumer Confidence, December (97.0 expected, 96.1 in November)

  • 10:00 a.m. ET: Existing home sales, November (6.7 million expected, 6.85 million in October)

  • 10:00 a.m. ET: Richmond Fed Manufacturing Index, December (12 expected, 15 in November)

Earnings

  • 6:50 a.m. ET: CarMax (KMX) is expected to report adjusted earnings of $1.14 per share on revenue of $5.01 billion

Top News

House and Senate pass $900 billion stimulus deal [Yahoo Money]

UK stocks fall as new COVID strain prompts economic paralysis concerns [Yahoo Finance UK]

Travel stocks recover from hit after countries ban flights from UK [Yahoo Finance UK]

Apple targets car production by 2024 and eyes ‘next level’ battery technology [Reuters]

Blockchain firm Ripple plans to fight approaching U.S. SEC lawsuit [Reuters]

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