Oppressed stock pickers see rebound opportunity

Stock pickers are hoping for a sustained comeback as market dominance of tech companies wanes in a recovering US economy.

The initial rally in US stocks in the pandemic era, which reached its first anniversary this week, was in big tech, with a handful of giants such as Apple and Facebook making up about a quarter of the whole at one point. of the S&P 500. benchmark stock index.

But now economically sensitive industrial, energy and financial companies are on the rise. In addition, companies within sectors are likely to chart very different paths out of the pandemic crisis. All of this offers better opportunities for stock selectors such as hedge funds and actively managed equity market portfolios.

“Now is the time to focus on stock picking and conviction investing,” said Tony DeSpirito, CIO of US Fundamental Equities at BlackRock. “This economic cycle will be faster and there is a lot of pent-up demand. The dynamics of the cycle will play on the strengths of stock pickers. “

A majority of active managers have not outperformed the broad S&P 1500 index of US equities since 2013. But signs of a broader market rally in late 2020 have helped active managers outperform in previous years. , according to S&P Dow Jones.

The majority of U.S. domestic equity funds have consistently underperformed the S&P 1500 in 2020, but the 57.1% figure is well down from 70% in the previous two years.

Client money has followed years of passive outperformance. At the end of 2010, actively managed U.S. equity funds held $ 4 billion in net assets, well above the $ 1.5 billion in passive index strategies, according to Morningstar. A decade later, passive US strategies have grown to nearly $ 8 billion in assets, a mustache behind active funds.

Fund managers say weakening reliance on technology stocks at this point in the economic recovery will help create more opportunities. In February, 70% of actively managed large-cap funds outperformed their benchmarks – the best performance since 2007 according to Bank of America.

Investors say companies are likely to behave very differently from each other during the economic recovery. Some have done a better job of cutting costs, preparing them for a strong rebound in earnings. Others have been more successful in hanging on to technological change, especially in retail.

Some stocks, however, are cheap for a reason. Distressed businesses laden with debt are unlikely to thrive after the pandemic ends.

“Long-term trends in technology and disruption are accelerating and the challenge for stock pickers is to distinguish how Covid is transforming businesses,” said DeSpirito at BlackRock. “This means that there are opportunities for stock pickers among value and growth companies. You have to find new tech disruptors and avoid value traps. “

Column chart of US equity funds split between active and passive strategies showing passive assets in equities have gained increasing share over the past decade

An even-weighted approach to the S&P 500 is another way to play a larger stock market rally, spreading allocations evenly among index constituents rather than tilting towards those with the largest market cap.

“Robust economic growth is a good environment for active managers to outperform the index, either through stock selection or through an equal weight approach,” said Marco Pirondini, head of US equities at Amundi Asset Management. “The economic forecast will be revised upwards during the year.”

In a sign of the wider range of stocks now pushing higher, an even-weighted version of the blue-chip S&P 500 index has gained around 32% in the past six months, or 11 percentage points. better than the same index weighted in favor of larger companies.

Line chart of S&P 500 indices (rebased) showing the Wall Street stock rally widened in the past six months

The broader rally in equities has also drawn net inflows to actively managed global equity funds so far this year, for the first time since 2013, according to Citi strategists. The main beneficiaries have been global equities, emerging markets and funds focused on sustainable investing, the bank said.

A lasting resurgence is a difficult task. “It’s a better time for active managers, but they need to be more discretionary and they still have a lot of work to do,” said David Bianco, investment director for the Americas at DWS Group.

Choosing stocks with low price-to-earnings ratios “is not a sustainable strategy,” Bianco said. “For active management to have its legs on this new cycle, it will have to continue to assess the economic outlook and the benefits for companies.”

But expectations of a significant rebound in economic activity are building and should drive corporate profits up sharply over the next 12 months. This will likely support the stocks of small and medium-sized businesses, which typically thrive during a strong economic recovery. Although these sectors have recovered strongly in the past six months, they remain cheap compared to large companies.

“Small companies retain a significant valuation discount to large-cap stocks,” said Jill Carey Hall, head of US small and mid-cap strategy at Bank of America.

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