Everyone’s tired of hearing the word “unprecedented” to describe the pandemic era. Cliched as it may be, however, there’s no denying the extent to which Covid-19 disrupted the familiar boom-and-bust cycle that governs economic recessions and rebounds. This is making it more difficult for investors to play the reopening trade because the depth and duration of this recovery will look different than ones in the past. The good news is that with markets soaring to new records, there is no shortage of winners to choose from. The tricky part is knowing how long those winners will be in favor.
A Recession Like No Other
If the recession of 2020 didn’t feel like a typical downturn, that’s because it wasn’t. In addition to personal income actually rising during the recession — due in part to stimulus checks — it is also the first recession in history driven by a collapse of the services economy. Even the experts have had trouble defining it. While the National Bureau of Economic Research (NBER) did call the recession last year, there hasn’t yet been an official declaration as to its end.
Shorter Run For Value And Cyclicals
Value and cyclical stocks tend to do well as investors begin to anticipate the economy transitioning from recession to recovery. Cyclical stocks, as their name suggests, are companies that tend to behave predictably based on where the economy is at in the business cycle — such as basic materials companies during a recovery. For this reason, cyclicals tend to be more economically sensitive. Value stocks, too, tend to perform well fresh off a recession. Because they are cheaper, investors feel more confident to buy these “riskier” names as the economy rebounds.
Last year was definitely recessionary, and that’s why growth stocks continued to do well; late-cycle investors tend to chase growth names in search of earnings growth, and the work-from-home environment further helped. Now that the economy has entered a recovery phase, value and cyclicals are having their moment. This is likely to persist for the next few months — typical of a post-recession environment — but their time in the sun may be shorter and hotter, like the recovery itself. I expect another rotation to occur as investor interest begins to shift toward large caps and growth later in the year. This anticipated shift stems from increasing concerns related to slower economic growth and earnings in 2022 as the tax implications of the new administration become clearer.
A Barbell Approach
Given how unprecedented the current economic cycle is, investors will want to remain flexible in their portfolio construction, pursuing diversification opportunities that allow them to capture upside potential, while minimizing downside risk. One way to do this is to adopt a “barbell” approach, which allows investors to balance value/cyclical exposure with disruptive growth companies. In terms of sectors that are poised to perform in coming months, conditions favor financials, industrials and basic materials stocks, while utilities, staples and real estate could see a pullback, especially with the increasing likelihood that interest rates will rise.
As the world begins to reopen, markets are likely to continue their rally. Still, savvy investors should keep a close eye on valuations. Stock prices are currently trading fairly high relative to earnings, an exuberance that is based on the stimulus and relief measures passed by Congress — and, more broadly, the belief that the pandemic is under control and will follow a predictable trajectory back to the old normal, if not even higher. Above all, it is important to realize that this recovery won’t follow the same script as previous recoveries, and investors should work closely with their financial professional to navigate the uncertainty that underlies the reopening trade.
This article originally appeared on Forbes.
