I can’t speak authoritatively about the industrial, financial and/or energy sectors, but for the last 10 months the consumer sector was filled with stocks like Dillard’s where estimates were obviously wrong by massive amounts. Estimates for cyclical stocks in consumer finally seem to be in the right galaxy, although not yet the right solar system, after a string of dramatic upside surprises which means that revisions for these stocks should slow down even in a “Roaring 20s” scenario. A stabilization/end to the dramatic positive sales, EBITDA and EPS revisions seen in more cyclical stocks will thereby improve the relative revisions of “secular” growth stocks. This needs to happen for the relative performance and stock prices of “secular” growth stocks to stabilize.
I became optimistic that every vaccine was going to work last summer and was convinced that the combination of multiple successful vaccines and unprecedented stimulus was likely to lead to the fastest GDP growth in my lifetime in 2021. Although this type of top-down view is rare for me, I was a cautious believer in the “Roaring 20s” hypothesis for consumer behavior and GDP growth. As a result, for the last 10 months, I have had a bias towards GDP sensitive stocks that could be valued on earnings rather than EV/S. Especially apparel retailers where even a few months ago it was easy to find stocks with 2022/2021 revenue estimates that were significantly lower than 2019, which seemed way too low. Running more accurate 2021/2022 revenues through these models led to 2021/2022 EPS estimates that were multiples of consensus estimates given their high incremental margins. Beyond significant near-term (2021/2022) upside, many of these companies have permanently improved their business models during Covid by closing stores, renegotiating leases and pulling forward many years of eCommerce growth and investment along the lines of what I outlined in this Medium article and for Target specifically in my presentation to help raise money for the SOHN Hearts & Minds Investment Conference 2020 philanthropies.
I have had similar biases in technology, where I have tried to avoid recurring revenue business models which are definitionally not GDP sensitive and within technology my ordinal ranking has been semiconductors/Internet advertising/e-commerce > payments > software. Even within software, I have tried to avoid pure recurring revenue models and own business models with embedded payments or transactional revenue models to give them more GDP sensitivity. Even those software stocks proved to be painful to own.
All of this began to change for me in the big secular growth sell-off in late March and has changed more decisively for me in May as estimates finally look more reasonable in most of the more cyclical sectors of the market, secular growth stocks have declined 30%–50% and many cyclical stocks are up 3x–5x over the last 10 months. Relative revisions are stabilizing, and relative valuations are more attractive. Secular growth stocks are increasingly attractive to me, although I will continue to own most of my consumer cyclicals as well, given they are still quite cheap.
Positioning is also much cleaner now. Per data from Prime Brokers*, US L/S hedge fund net exposure to Large Cap Tech is now down to the 23rd percentile over the last 12 months (note: it’s been in the ~75th percentile since 2010). ETF flows show Tech is in the 1st percentile on a one-year basis (or the lowest out of all 11 sectors), while Growth is in the 0th percentile. By way of comparison, Financials sits in the 100th percentile, Industrials and Materials each in the 99th percentile, and Energy the 94th percentile. The same hedge funds and ETF buyers that had historically high net exposure levels to secular growth and technology names at their peak relative performance in the late summer now have much lower net exposures. Cleaner positioning, lower relative valuations and stabilizing relative revisions are positive for secular growth. The time to rotate to cheap cyclicals exposed to vaccines, reopening and accelerating GDP was roughly three quarters ago, not today. It’s easy to “Be greedy when others are fearful and fearful when others are greedy,” but much harder to actually do this.