As we close the first half of 2020, large-cap US stocks have gained back nearly all losses suffered in the violent March sell-off spurred by the coronavirus pandemic.
One of the surprising things about the downturn and robust recovery is that momentum and growth stocks have continued to lead.
Typically, defensive sectors such as healthcare and consumer staples hold up best in bear markets while cyclicals such as industrials lead recoveries, especially those supported by policy stimulus.
It is surprising but explainable as technology has been less cyclical due to the nature of the virus shutdown and work from home scenarios as the pandemic has accelerated digital transformation.
One of the surprises of Q1 earnings results was the broad strength of results and outlooks across technology, with information security, cloud and data related names among the best performers.
One factor that has remained constant since early March is heightened volatility. The CBOE Volatility Index or VIX, spiked to its highest levels in over 30 years in the first quarter and has remained well above average.
We expect volatility will continue at these levels as a number of uncertainties are still present: the trajectory of the virus as we see a second wave of infection in some regions that have reopened their economies, the willingness of consumers to go out and spend again, the comeback in employment after massive layoffs and the size of a potential new fiscal stimulus package from Congress.
These questions prevent companies from having much visibility in terms of demand and earnings and we expect earnings weakness through at least the third quarter across most sectors of the economy.
Greater volatility provides more opportunities for active managers to take advantage of temporary mispricings to establish new positions or add to existing ones in quality companies that in the past may have been too expensive for purchase.
The market is factoring in a V-shaped recovery with S&P 500 earnings expected to recover in 2021 to a slight increase over 2019.
Clearly that is the case for some companies such as UnitedHealth Group, Facebook, Nvidia and Amazon, which have a good fighting chance of growing earnings. Other companies in areas like aerospace, autos and travel will have a much tougher time.
Investors may be overly optimistic about certain sectors, but the stimulus in the market allows for discounting a recovery further out.
We believe segments of the technology and healthcare sectors offer the best investment opportunities for the remainder of 2020. The work from home dynamic is causing investment and sales to be pulled forward across the software and cloud-related areas of IT, which encompass not only companies such as Microsoft, which is seeing strong uptake for its Office and Teams applications, but also names such as Splunk, Palo Alto Networks and VMware that provide security and support around cloud applications being run by enterprises.