05 Jun Where to from here?
The tech-heavy Nasdaq100 index touched a new record high on Thursday, before falling a touch into the close. This is not a high since the start of coronavirus. This is a new all-time record high despite everything.
The index has rallied more than 40% from the March lows, but Wall Street analysts still think some of the biggest names have further to run. For example, analysts believe Western Digital (WDC) and Micron Technology (MU) have 20% upside from here.
How can stocks be soaring when 42million Americans are unemployed and it is forecast 1 million small businesses won’t survive?
It is because the market is forward-looking. Coronavirus is over. Yes, we know there will be a second wave and maybe a third but as time moves on the worst falls behind us and more and more people develop natural immunity. Economies are re-opening. Things are improving and for investors that means it is time to buy.
Add to that The Federal Reserve is propping up risky assets and Congress is flooding the economy with money and you can see why traders aren’t worried.
The biggest driver we see is the massive amount of money being printed. That devalues the dollar and explains why the Aussie is up and over 0.69 to the USD.
Many think inflation is the cost of assets increasing over time. But, more accurately, it is the value of money losing value over time. With more money in the system the value of each dollar is less which means you need more of those dollars to exchange for an asset.
Stocks are assets too.
Now we can understand why the market is likely to continue to head higher, the question becomes where do we look for the most gains?
Let us ask our friend Nick Colas at Data Trek Research who has a near term target of 3,430 on the S&P500, which is about 10% higher than where is it now. He argues the way there is paved with financials, industrials and consumer discretionary. Here is why:
Technology, which is 26% of the S&P500 currently trades for the same PE as when it made its February highs (23.2x now 23.1x then). A 10% move higher would put it at 25.5x. That is possible but betting on further expansion from this already expensive group cannot be the lynchpin of any near-term case.
Health Care is 15% of the S&P500, well above its 10-year average of 13.9%. History shows weightings of 15% in the index are uncommon so we can’t rely on this group either.
Financials, however, can help propel the S&P forward. They are 11% of the index currently verses an average weight of 14%. Financials also have the lowest multiple of any S&P sector (15.1x) and still trade 21% below their February highs.
Industrials, at an 8% weight, are expensive (25.0x) but are 16% below their February highs. This sector is full of US economic recovery plays, Union Pacific (UNP), Honeywell (HON), United Parcel Service (UPS), and Caterpillar (CAT) for example.
In the Consumer Discretionary sector, you have the likes of Home Depot (HD) and Lowes (LOW) which have already broken out to new highs but companies like McDonalds (MCD), Nike (NKE) and Starbucks (SBUX) have not.
Bottom Line: the next 10% index gains are going to all be about post-COVID economic recovery.
One easy way to play this theme is via the ETF – MGV. This is the Vanguard Megacap Value which is 19% financials and 10% industrials and should see some nice gains as the economy gets back on track.