Expensive stocks become more expensive as cheap ones stay cheap

Chart of the week

Covid-19 did not put an end to the sectoral imbalances in equities. Late-cycle favorites remain popular. Clearly, this is no regular upswing. Can it last?

Old Wall Street hands know that there is a piece of stock-market wisdom to explain just about any event – and the opposite. Investors who were worried about catching a falling knife in stock markets in mid-March will feel less joy today when looking at their portfolio than the more courageous ones who bought when the market panic was at its peak. Investors who thought that, ultimately, it's all about profits, were, at least in the short term, at a disadvantage to those who seemed to know not to bet against the U.S. Federal Reserve (Fed) (representing all the major central banks). And those who bet on "mean reversion," i.e. movements back to long-term averages, based on the thinking that no trend lasts forever and a rotation of investment styles is accordingly inevitable, are still waiting for that to happen. The same is true for those who expected value stocks to initially perform best, as typically tends to happen when economies and markets rebound.

While it is true that on several occasions this week value stocks have outperformed growth stocks by a wide margin, such movements pale against the trend in favor of growth that has been in place since 2007. The growth segment is once more dominated by the technology sector, especially U.S. names. Therefore, this sectoral imbalance, which is also reflected in regional return deviations, becomes most apparent when comparing the U.S. information-technology sector with the European banking sector (representing value stocks). While the former is ahead by more than 5% this year, financial stocks have declined by half.

Our "Chart of the Week" indicates that this is not an isolated phenomenon. The rally of the past three months was mainly driven by those sectors already deemed to be pricey by conservative standards (when looking at price-to-earnings (P/E) ratios), while the cheap ones continued to be avoided. Incidentally, the corresponding stock-market saying is "cheap for a reason." Does this, to the contrary, mean that sectors doing well so far are so expensive for a good reason? After all, one might wonder for how long individual sectors can experience a bull run if so many other sectors remain troubled due to the ongoing economic slump? What if, as we estimate, the United States will not reach its 2019 output level until 2022? Other asset classes (commodities or bonds, for example) are not exactly pricing in a rapid economic recovery, either. That would at least explain why value stocks continue to perform relatively weakly: because this is no regular upswing. This, is also the reason why we stick to some of these expensive sectors, at least on a relative basis. In unusual times, it makes little sense to fight the Fed or to fight big tech.

20200529_CotW_PER-and-Performance_CHART_EN_72DPI.png

* from 2/26/20 to 5/26/20
** Price-to-earnings ratio as of February 19 (market peak), based on trailing 12-month earnings.
Sources: Refinitiv, DWS Investment GmbH; as of 5/27/20

Appendix: Performance over the past 5 years (12-month periods)


04/15 - 04/16 04/16 - 04/17 04/17 - 04/18 04/18 - 04/19 04/19 - 04/20
Communication services 9.8% 0.4% -2.6% 15.9% 3.3%
Consumer discretionary 6.9% 15.8% 16.8% 16.9% 1.7%
Consumer staples 10.9% 8.6% -6.1% 18.4% 3.6%
Energy -13.9% 2.1% 12.4% -7.3% -38.3%
Financials -1.5% 27.1% 18.6% 4.3% -16.8%
Health care -1.1% 10.1% 10.9% 10.5% 14.5%
Industrials 4.1% 19.4% 8.8% 10.5% -15.9%
Information Technology -0.1% 35.4% 24.6% 22.8% 18.1%
Materials -4.3% 15.2% 9.2% 3.0% -7.2%
S&P 500 1.2% 17.9% 13.3% 13.5% 0.9%
Utilities 13.7% 10.6% 3.2% 18.0% 0.8%

Sources: Bloomberg Finance L.P.; DWS Investment GmbH as of 05/28/20
Past performance is not indicative of future returns. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect.

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