We continue to make progress in the struggle against COVID-19. The global economic recovery is underway. Corporate earnings are expected to increase, and the outlook is turning more positive. Threats and fears always remain, but the path forward looks bright and global stock markets are generally reacting as such. U.S. stocks, as measured by the S&P 500 Index, returned 6% in the first quarter, including dividends and non-U.S. stock markets, as measured by MSCI’s All Country Worldwide Ex-U.S. benchmark, returned 4% including dividends.
Upon closer inspection, performance at the stock and sector levels was uneven, volatile, and inconsistent when compared to what has occurred over the last few years. The tech-heavy NASDAQ Composite Index, a decisive outperformer for many years, returned a mere 2% in the quarter. Furthermore, the NYSE FANG+ Index, consisting of Facebook, Apple, Amazon, Netflix and Google was barely in positive territory at the end of March. At the same time, smaller market-cap stocks, as measured by the Russell 2000 Index, returned more than 10% in the quarter.
Numerous cross currents, depending on the day, created meaningful divergences in stock prices throughout the quarter. A few examples of
these market movers (but far from an exhaustive list) include interest rate volatility, inflation fears, changes in expected Federal Reserve stimulus,
speculation about policy changes under the new presidential administration, potential regulation of big tech, etc.
It is difficult to separate each of the aforementioned drivers and pinpoint their impact on stocks, because more often than not, it was simultaneous
narratives that were driving stocks during the quarter. For instance, improving economic activity served to lift more cyclically sensitive stocks. Rising interest rates negatively impacted tech stocks as higher rates make other stocks (banks, for instance) increasingly attractive, thereby reducing the valuation premium investors are willing to pay for tech-driven growth.
In terms of Federal Reserve stimulus, investors and stock markets are demanding just enough. In other words, too much stimulus (and caution) by
the Fed could signal the economic recovery is still far away, causing investors to reduce stock exposure. On the other hand, not enough Fed stimulus could signal a more imminent removal of the easy money “punchbowl.” This is a very tender balance to achieve and implies the perfect amount of caution for the Fed to continue its easy money policies, providing a boost to corporate profits and stock prices, without leading investors to fear the markets are too far ahead of fundamentals.
Making sense of it all: Investors find themselves at a crossroads. We have all been anticipating the end of the COVID-19 battle and markets have clearly discounted a recovery as the S&P 500 returned +58% since the market bottom on March 23, 2020. We believe that a cyclical upswing in economic activity is imminent. Large cap tech stocks should continue to grow earnings and cash flow, over the long-term, at a faster clip than the overall market. However, it is easy to imagine these stocks underperforming others, as they did in the first quarter, at least for some period of time during the recovery. The rationale for this is simple: as the economy recovers, growth is more broadly available. Therefore, there is less reason for investors to pay up for growth by buying large cap technology stocks trading at premium valuations.
Howland Capital’s approach to this environment is to stay focused on the long-term while paying close attention to portfolio construction in order to weather the near-term choppiness. Our investment philosophy and process – which have benefitted our clients for more than five decades – remain the same: we invest in high quality companies with long-term, sustainable competitive advantages translating to superior earnings, dividend and cash flow growth.
While our approach tends to favor larger market-cap, growth-oriented stocks, we are also valuation sensitive. In addition to growth-oriented stocks, our clients’ portfolios hold value-oriented stocks that stand to benefit when other holdings do not. We believe in broad sector and business model diversification that should at least provide a performance buffer in the event we continue to see disproportionate returns across sectors. Finally, and
most importantly, we emphasize companies that we believe will exceed sales, earnings, and cash flow expectations over the long-term. The market is most likely to reward these stocks regardless of whatever else is going on in the world.