Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 404

A year like few others, but what's next?

The one-year anniversary of the low point in the S&P 500 index during the pandemic was 23 March 2021, so we want to put the trailing one-year return of 77% into context as we look ahead.

This was a rare event

With the help of Bernstein Research, we calculated trailing 12-month returns for every month-end beginning in 1882. We then aggregated all the return streams into buckets, as shown below. So, how rare was this past year’s return? Extremely.

Exhibit 1: Only a handful like it

All five previous examples of 75% or greater 12-month trailing returns occurred during the Great Depression of the 1930s, another period of extraordinary government economic intervention.

What’s unique about the response to the coronavirus pandemic is the speed at which the US economy exited the recession once the US Federal Reserve put a floor under credit risk.

Markets may be short term, but they’re not dumb

Financial markets are a discounting machine. They tend to ignore seemingly material factors such as high unemployment while zeroing in on things that really matter, such as free cash flow generation.

For instance, in the quarters preceding Franklin D. Roosevelt’s New Deal, investors looked through intense economic pain and suffering in anticipation of an explosion of economic growth in 1934. What followed was a strong, but short-lived, business cycle. After the effects of the early-New Deal stimulus had worn off in 1937, worries about deficits resulted in spending cuts and the economy contracted again. Financial markets anticipated that too, as evidenced by the rollercoaster market returns throughout the 1930s.

Bringing it back to the present day, following the lows of last March, the beneficiaries of the initial phase of the rally were stay-at-home stocks such as streaming services and video conferencing providers.

However, as the weeks passed, investors began to look though the uncertainty surrounding the virus to what could be a massive snap-back in US economic growth in the second half of 2021. They switched their focus, shifting capital away from free-cash-flow compounders — companies that are typically more in control of their own destinies — and toward the stocks and credits most leveraged to the economic outlook: cyclicals.

The significant outperformance of companies with highly indebted balance sheets or lower-quality income statements is characteristic of the early phase of a market cycle. Regardless of quality, those companies that are most directly leveraged to a rebound in economic growth have historically become market darlings. That pattern played out during the previous two business cycles, after the collapse of the dot-com bubble and again in the wake of the global financial crisis.

I don’t discount what the market is signaling. It may be short term, but it’s not dumb. The combination of an exceedingly high US savings rate (thanks to pandemic-driven government transfer payments) and pent-up consumer demand (after more than a year of lockdowns) should lead to an enormous pop in economic growth.

Exhibit 2: US stimulus has ballooned savings

Cross-cycle compounders will replace cyclicals

Most investors focus on the near term. That will probably never change. Therefore, it comes as no surprise that the market’s ability to predict what will happen in the short term is strong but weakens over the medium and long term. That’s why our focus is always on the out years.

At some point, as they always do, financial markets will look through the coming eye-popping economic statistics. They will begin to discount what business fundamentals will look like without the tailwind of exceptionally accommodative fiscal and monetary policy.

And if history is any guide, we expect that as policy normalises, investors will pivot back to the type of cross-cycle earnings-compounders that make up many of our core holdings. These 'compounders' grow or 'compound' their earnings better than lesser companies across cycles as their revenues hold up in difficult conditions. They deliver strong cross-cycle earnings growth.

Cyclicals will have had their day, as they often do in the early phases of a market cycle, but we believe secular trends will win out in the long run, rewarding patient investors as the cycle matures.

 

(Editor's note: A stock is secular when company earnings remain relatively constant regardless of other trends. Examples are consumer staples or products that households consistently use. A cyclical stock's price is more affected by changes in the economy).

 

Robert M. Almeida is a Global Investment Strategist and Portfolio Manager at MFS Investment Management. This article is for general informational purposes only and should not be considered investment advice or a recommendation to invest in any security or to adopt any investment strategy. Comments, opinions and analysis are rendered as of the date given and may change without notice due to market conditions and other factors. This article is issued in Australia by MFS International Australia Pty Ltd (ABN 68 607 579 537, AFSL 485343), a sponsor of Firstlinks.

For more articles and papers from MFS, please click here.

Unless otherwise indicated, logos and product and service names are trademarks of MFS® and its affiliates and may be registered in certain countries.

 

RELATED ARTICLES

Why stock prices are a distraction

The options to gain equity exposure with less risk

Is your fund manager skilful or just lucky?

banner

Most viewed in recent weeks

Are term deposits attractive right now?

If you’re like me, you may have put money into term deposits over the past year and it’s time to decide whether to roll them over or look elsewhere. Here are the pros and cons of cash versus other assets right now.

Uncomfortable truths: The real cost of living in retirement

How useful are the retirement savings and spending targets put out by various groups such as ASFA? Not very, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

How retiree spending plummets as we age

There's been little debate on how spending changes as people progress through retirement. Yet, it's a critical issue as it can have a significant impact on the level of savings required at the point of retirement.

Where Baby Boomer wealth will end up

By 2028, all Baby Boomers will be eligible for retirement and the Baby Boomer bubble will have all but deflated. Where will this generation's money end up, and what are the implications for the wealth management industry?

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

20 US stocks to buy and hold forever

Recently, I compiled a list of ASX stocks that you could buy and hold forever. Here’s a follow-up list of US stocks that you could own indefinitely, including well-known names like Microsoft, as well as lesser-known gems.

Latest Updates

Property

Financial pathways to buying a home require planning

In the six months of my battle with brain cancer, one part of financial markets has fascinated me, and it’s probably not what you think. What's led the pages of my reading is real estate, especially residential.

Meg on SMSFs: $3 million super tax coming whether we’re ready or not

A Senate Committee reported back last week with a majority recommendation to pass the $3 million super tax unaltered. It seems that the tax is coming, and this is what those affected should be doing now to prepare for it.

Economy

Household spending falls as higher costs bite

Shoppers are cutting back spending at supermarkets, gyms, and bakeries to cope with soaring insurance and education costs as household spending continues to slump. Renters especially are feeling the pinch.

Shares

Who gets the gold stars this bank reporting season?

The recent bank reporting season saw all the major banks report solid results, large share buybacks, and very low bad debts. Here's a look at the main themes from the results, and the winners and losers.

Shares

Small caps v large caps: Don’t be penny wise but pound foolish

What is the catalyst for smalls caps to start outperforming their larger counterparts? Cheap relative valuation is bullish though it isn't a catalyst, so what else could drive a long-awaited turnaround?

Financial planning

Estate planning made simple, Part II

'Putting your affairs in order' is a term that is commonly used when people are approaching the end of their life. It is not as easy as it sounds, though it should not overwhelming, or consume all of your spare time.

Financial planning

Where Baby Boomer wealth will end up

By 2028, all Baby Boomers will be eligible for retirement and the Baby Boomer bubble will have all but deflated. Where will this generation's money end up, and what are the implications for the wealth management industry?

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.