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The song we chose this week to embody the sentiment of the stock market is Country Star Scott McCreerys song, In-Between. The lyrics that speak to the recent change we are seeing as sectors like Tech (Growth) and Healthcare take a breather and other sectors like Financials and Industrials (Value/Cyclicals) […]

The song we chose this week to embody the sentiment of the stock market is Country Star Scott McCreerys song, In-Between.

The lyrics that speak to the recent change we are seeing as sectors like Tech (Growth) and Healthcare take a breather and other sectors like Financials and Industrials (Value/Cyclicals) catch a bid (to pick up some of the slack) are:

Aint too highAint too lowJust holding down the middleIm steady as I go

A couple of weeks ago, we laid out the case for the Most Loved stock in the S&P 500 (AAPL) being overvalued, and the most hated stock in the S&P 500 (WFC) being undervalued. You can review it here:

The Stevie Wonder, Faith Stock Market (and Sentiment Results)

Right after that note, the tide shifted abruptly. Here is a ratio chart of the performance of WFC:AAPL since:

To address the skeptics of my thesis, in the note I said, I can hear it now, Wells Fargo will begin to outperform Apple on a relative basis WHEN PIGS FLY’ Yesterday I tweeted the following to represent the persistence of this new trend:

On Tuesday, I was on Fox Business (The Claman Countdown) with Liz Claman. Thanks to Ellie Terrett for inviting me on the show. The question posed to me was whether it made sense to buy Tech, or look elsewhere. I addressed a number of findings from the Bank of America Global Fund Manager Survey (that was published on Tuesday morning) and listed the financials we preferred over tech. View it here:

On Monday, I was on Cheddar TV with Brad Smith. Thanks to Francesca Conti for inviting me on the show. I talked about the imminent vaccine as a catalyst for the rotation into cyclicals, and went into granular detail about one key factor in our Banks thesis CECL. CECL which stands for Current Expected Credit Loss is an accounting change that went into effect in Q2 2020 which made the banks results look much worse than they actually were/are. Watch this segment to learn the specifics:

The key takeaway is that the Big 4 banks reported ~$5B in pre-tax income for Q2 2020 versus ~$34B in 2019. That looks BAD, and thats one of the key reasons banks were pummeled in Q2.

HOWEVER, if you take away the paper change of CECL and compare APPLES to APPLES with the 2019 standards, the Big 4 actually reported $28B in Q2 2020 (a year on year decline of $6B NOT $29B). Not bad considering we shut down the world for several months.

And the kicker? The Over-Reserved banks will start to reverse those excess reserves (~$23B worth as they took $28B of reserves in Q2 2020 versus $5B in Q2 2019 due to CECL) in coming quarters and years. These reversals will come back as income (Earnings) moving forward.

While everyone is focused on the Fed keeping short rates low for the next three years, they miss the forest for the trees as the yield curve continues to steepen. This will begin to improve NIM (net interest margin) for banks over time. It works EVERY single cycle:

Just today, the Fed took their 2020 GDP estimates up to -3.7%. Remember when the IMF came out in June with -9% 2020 GDP expectations for the US? Never bet against America

No Pain, No Gain

For everyone who was skeptical about the rotation, its happening now. While it can be a bit painful in the short term for those who are overweight TECH, it is very healthy in the long term (for the general market) as the rally broadens and laggards start to participate (and outperform on a relative basis). Heres the recent pain in FAANGM:

With ominous anti-trust winds swirling around Washington, it may get worse for this small cluster (and several others in the sector) before it gets better. Time will tell

What the Big Money is Doing

On Tuesday, we put out a summary of the September Bank of America Global Fund Manager Survey. This month ~224 managers running >$600B AUM participated. You can find it here:

September Bank of America Global Fund Manager Survey Results (Summary)

The key findings were as follows:

There is still some skepticism (Wall of Worry to Climb):

  • 29% of respondents (down from 35%) still believe its a bear market rally.
  • 61% of respondents predict U- or W-shaped recovery.
  • 20% say V-shaped recovery.
  • Cash levels rose from 4.6% to 4.8% (greed 5%).
  • Net 18% of investors are overweight equities, but far from dangerously bullish.

They are rotating out of technology:

  • 80% believe Long US Tech most crowded trade of all time (up from 59% in August). OF NOTE: 1-month return reversal occurs after peak crowded trade in 14/22 months in past decade.
  • Michael Hartnett (BofA), said fund managers signaled that they are paranoid tech and have been decreasing their allocation to the sector in favor of more cyclical equities, such as cheaper value shares, small-caps and industrials.
  • Survey shows switch into cyclicals, out of tech.
  • Rotation continues: tech, healthcare, large cap longs trimmed.
  • Industrials at highest overweight since Jan18.
  • Flows to small cap & value up.

Yield Curve:

  • 41% say credible COVID-19 vaccine most likely trigger for higher bond yields. This will help NIM (Net Interest Margin) for banks.
  • 37% say Inflation most likely trigger for higher bond yields.

The Rotation Makes Sense

As I mentioned on Liz Clamans show, this rotation is consistent with Earnings Expectations for 2021 as Tech is only going to grow at 1/2 the pace of the S&P 500:

Growth Stocks outperform in a slow-growth economic environment because managers have limited choices where they can buy earnings growth. Tech and healthcare command premium multiples as supply is scarce and demand is plentiful.

In the beginning of a new cycle (we just had the recession with 2 quarters of negative GDP in Q1 and Q2 and are now flying out of it into the new cycle) economically sensitive stocks outperform (Financials, Industrials, Homebuilders, Defense Stocks, Materials, Energy, etc).

Managers begin to have more options to buy earnings growth and turn to better valued options (less money for more earnings). The supply of growing companies expands to match demand so that money is no longer concentrated in just a handful of options. Valuations come down on growth stocks and pick up on value stocks (as money shifts).

Not only will S&P Earnings grow +26% in 2021, but GDP is projected to be north of +6% (a number we havent seen in decades). Furthermore, the Atlanta Fed now has Q3 2020 GDP projected to come in at +31.7%!

So you now have a healthy rotation now taking place, rates will remain low for some time, and the Fed committed to continued asset purchases until they near full employment:

Chairman Powell repeated that the Fed will continue buying Treasuries and mortgage-backed securities at least at the current pace to sustain smooth market functioning. They committed to $80 billion of Treasuries per month and $40 billion of mortgage-backed securities.

The Chairman who had one of the shakiest starts in history will now likely go down as one of the greatest in history after saving the country from a Great Depression this Spring (along with Secretary Mnuchin, Larry Kudlow and the Administration). They made it look easy, but their performance in time of crisis was unparalleled in history. We should all be grateful as the outcome could have been a lot different

Now onto the shorter term view for the General Market:

In this weeks AAII Sentiment Survey result, Bullish Percent (Video Explanation) jumped to 32.02% from 23.71% last week. Bearish Percent dropped to 40.39% from 48.45% last week. While optimism creeped in this week, it did not jump to euphoric levels. It is right in the middle of the range

The CNN Fear and Greed Index slid from 66 last week to 56 this week. Fear has crept in, but not at an extreme level. This indicator is also in the middle of the range. You can learn how this indicator is calculated and how it works here: (Video Explanation)

And finally, this week the NAAIM (National Association of Active Investment Managers Index) (Video Explanation) crashed from 94.71% equity exposure last week, to 53.09% this week. A lot of managers were shaken out by the quick drop in AAPL and FAANGM:

Our message for this week:

As I have repeated for a few weeks, the catalyst for change (an abrupt move of money into Cyclicals) will likely come from science at this point. Dont bet against science.

We now have 9 vaccines in phase 3 and the market is starting to ease into the re-opening trade (Cyclicals) in anticipation of the imminent vaccine approval.

We are in an in-between period. Given the overweight to tech, my sense is there is still some more to work out in coming weeks for some of the overvalued pockets of tech/saas, etc. The pain trade is still down for some of the over-owned names.

However, I do not think we are in for a major wholesale correction. Theres enough money that has yet to broaden their exposure and get positioned for the re-opening trade move into cyclicals/value.

These economically sensitive names outperform in the early/high economic growth stages of a new cycle which we have started in Q3. We will take advantage on any weakness as opportunity abounds in coming months

Thomas J. Hayes is Chairman and Managing Member of Great Hill Capital, LLC (a long/short equity manager based in New York City).  He started  as a platform to share actionable insights, tips and research for Hedge Funds, Institutions and Individual Traders to benefit from – based on what he has learned in his years of experience in the Hedge Fund industry. You can read his full bio at the site below.

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