Are US growth stocks getting out of hand?

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Over the past four years, the stellar winning streak of US growth stocks has put value stocks to shame. Thanks to the quantitative easing policies the government and the Fed rolled out last year to flood the market with liquidity, and a surge of retail inflows, tech stocks have notched record highs – similar to the elevated levels that precipitated the collapse of the dotcom bubble in 2000. Understandably, retail investors have resorted to online day-trading to ease pandemic boredom, with many of them diving into the market to chase momentum. While the lofty gains have befuddled most investors, some, including professional investors, have begun to wonder: are growth stocks overheated? Is now the time to shift some parts of the portfolio to value stocks?

You have probably heard the story about Joe Kennedy and the shoeshine boy. Just before the Wall Street Crash of 1929, as Joseph Kennedy Sr. got his shoes shined, the shoeshine boy started sharing with the father of the US’s 35th President his take on stocks, prompting Kennedy to realise that the market might have been overheated. Shortly after he sold his entire stock holdings, the market crashed, hard.

In fact, whenever the stock market overheats, it releases all sorts of signals. The question is, however, whether investors are able to catch them and interpret them accurately.

Indeed, it’s not easy to remove oneself from the growth stock-fueled euphoria. Deciphering these signals is already a tough feat, those who are able to act on them in a timely manner like what Joe Kennedy Sr. did are far and few between. As economist John Maynard Keynes once said, “the markets can remain irrational longer than you can remain solvent.”

Through our analysis below, we hope to share with you our views on why the market looks overheated. But we will leave it up to you to decide whether valuations have peaked.

Firstly, some stocks’ valuations have soared to frothy levels. The only way investors can rationalise the sky-high valuations is if they factor future earnings predictions into their analysis. One of the most cited examples is an electric vehicle (EV) maker, which only sold around half a million vehicles last year, and accounted for less than 1% of the global auto market share in 2019[1], [2]. Even so, in this January, its market cap once well exceeded that of the 14 biggest automakers across Europe, US, Japan and Korea combined2. Together, they made up over 86% of the total market share in 2019[3]. There’s no question that this particular EV maker has an innovative vision, and is committed to realising it, but even the greatest company has a limit to which its value can grow. So unless it is going to monopolise the auto industry, we think its current valuation is unsustainable. This, in a way, reflects the state of most growth stocks.

Secondly, speculative stocks have begun to crop up in the market. 480 IPOs took place in the US last year, the highest number in 21 years, of which over 200 went public as SPACs (Special Purpose Acquisition Company), far above year 2019’s figures[4], [5]. So what’s a SPAC? A SPAC is basically a shell corporation, or “blank check” company as some would say. Within two years of a SPAC’s IPO, the sponsor would typically seek to identify potential assets for acquisition. So a SPAC investor has very little idea of what the acquisition target company will be, and at what price. The acquired company can also bypass the registration process that would otherwise be required in a conventional IPO process. Ultimately, the quality of the target company lies in the hands of the company management. So SPACs are in a way slightly speculative, and are considered risky. Last year’s SPAC rush also indicated the enormous amount of money that have been sloshing around in the market. In our view, an expanded risk appetite is a tell-tale sign that the stock market has indeed become frothy.

Thirdly, if we calculate the overall valuations of US stocks using the Buffett indicator, which compares the total value of the stock market to GDP, it has already exceeded the level seen in the dotcom bubble – certainly not reasonably priced at the moment[6].

[1] Source: CNBC, as of Jan 2021

[2] Source: CompaniesMarketCap.com, as of Jan 2021

[3] Source: Autocar, As of Jan 2021

[4] Source: StockAnalysis, as of Jan 2021

[5] Source: Yahoo Finance, as of Jan 2021

[6] Source: Buffett Indicator, as of Jan 2021

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.

Market outlook: Five key themes in 2021

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2020 was an unusual year, to say the least – loose monetary policies and government handouts had spurred the US equity market to rebound, climbing higher despite the devastating damages COVID-19 inflicted on global economies.

Tech stocks, in particular, have reached new highs with these companies benefiting from more people working from home and spending more time indoors. But standing in stark contrast were traditional economy stocks: these businesses have largely suffered from the overall economy contracting, while some have shut down permanently.

Here are five forecasts for the global economy in 2021:

Firstly, we think a V-shaped recovery in global economies is on the horizon. Market consensus has it that the time frame of recovery is closely tied to that of mass vaccination campaigns.

According to Imperial College London’s research on the first wave of the pandemic, as the age of infected individuals increased by eight years, the virus’s infection fatality ratio (IFR) would double.

For individuals under 40 years old, the IFR was lower than 0.1%, but it surged to greater than 5% among those aged over 80[1]. The institute’s calculations also suggested that the IFR for infected persons aged between 50 to 55 was around 0.38%, so vaccinating those aged 50 or above can greatly alleviate the burden the pandemic has put on intensive care units1. This is also expected to gradually flatten the curve, which in turn will quicken the pace to restart the economy. 

According to the United Nations, as of 2020, close to 1.9 billion, or 24.2%, of the 7.8 billion global population were aged 50 or above[2], [3].

In 2021, the combined output of COVID-19 vaccines manufactured by Pfizer, Moderna and AstraZeneca will reportedly reach around 5.3 billion doses, which can be administered to between 2.6 to 3.1 billion people[4]. We believe the pandemic should subside considerably if we also take into account additional shots developed and distributed by other producers and Chinese manufacturers.

Moreover, household savings in developed countries have swollen over the past few months as working from home has gone mainstream. In our view, as soon as the pandemic is brought under control, pent-up consumer spending will be released, putting global economies on a V-shaped recovery trajectory.

Secondly, we think the US dollar will continue to weaken. This is down to the Federal Reserve’s balance sheet and M2 money supply ballooning under the former’s ultra-loose monetary policies and government handouts rolled out to prop up the economy amid the pandemic.

And if future policy directions are guided by the Fed’s chair Jerome Powell and, potentially, Janet Yellen, who has recently gained US President-elect Joe Biden’s confirmation as the next Treasury Secretary, the current policy setup will likely become the norm given their dovish stance, which will continue to weigh on the dollar’s strength. Historically speaking, a weak dollar has benefited Asian economies and stock markets.

Thirdly, we think the return of inflation is no longer a remote possibility. The US’s current loose monetary policies have been unprecedented, its level of aggressiveness unseen in the global financial crisis back in 2008. The government’s cash handouts have also directly expanded the money supply, leading to the biggest growth in M2 in 60 years, with some economists warning against potential inflation risks[5].

Over the past decade or so, inflation rates in developed countries have been treading at low levels with many investors growing complacent with a low-inflation environment supported by accommodative monetary policies.

So if inflation does return, the returns on fixed-rate government bonds will be among the first to suffer.

As for equities, strong companies with more pricing power may see their profits grow if they are able to pass on the cost of inflation to customers. In the scenario where inflation picks up, we think the ability to identify quality companies is vital in equity investing.

Fourthly, we see value stocks becoming more favourable over this year. Growth stocks have significantly outperformed value stocks in the past two years. After the outbreak of coronavirus, especially, investors have stockpiled technology companies’ shares. So in a post-pandemic world, traditional value stocks will likely gain more appeal among investors.

Lastly, the US will maintain its diplomatic approach towards China. US President Donald Trump, with his “America First” policy during his time in office, has taken aim at Beijing in an attempt to narrow the country’s trade deficit with China. With the new Secretary of State Antony Blinken assuming office alongside President-elect Joe Biden in January, we think the US’s current approach towards China will not change fundamentally given the former’s hawkish stance.

In the eurozone, however, we don’t think now is the right time yet to forecast how the region’s policy towards China will be headed. While the EU’s leader, German Chancellor Angela Merkel, has taken on a relatively practical approach, it’s not known yet who her successor will be after she steps down next fall.

[1] Source: Imperial College London, as of Oct 2020

[2] Source: UN Department of Economic and Social Affairs, as of Dec 2020

[3] Source: Worldometer, as of Dec 2020

[4] Source: Nature, as of Nov 2020

[5] Source: CEIC, as of Jan 2021

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.