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AAM Viewpoints – Mind the Gap




  • Recently there has been a rare divergence of performance between the NASDAQ-100 (large cap tech) and the Dow Jones Industrial Average (DJIA). Historically, such a divergence has tended to mark a change in market leadership.
  • Valuations on “non-profitable” listed equities were parabolic but have now started to roll over.
  • History appears to possibly be repeating itself as the decade-long leadership of Growth over Value could be coming to an end.
  • Investors should take heed. While we don’t see a market crash in 2021, we do believe that asset allocation models should accommodate a larger a dose of Value.

The first quarter of 2021 witnessed the continued migration from Growth to Value stocks. The performance gap between Growth and Value (as measured by the corresponding Russell indices) has narrowed significantly. This is something that – albeit expected – is a normal rotation that happens in every economic growth cycle. This time it was a little frustrating in that we had this thing called a virus that kind of jumbled the crystal ball for many analysts. What is very interesting to us is the divergence of the leadership that has been at the top of performance of this bull market. That gap likely may be a harbinger of change in long-term leadership.

First, let’s start off with the recent divergence we have seen in the NASDAQ Composite Index performance and the DJIA. We have had three recent days when the NASDAQ was down more than 2% and the DJIA was up more than 2%. Remember that the NASDAQ Composite is dominated by technology growth companies while the DJIA has a greater concentration of companies that include Value names. The days when this disparity in returns occurs tend to be very few and far between. The last time we saw this “gap,” or divergence, in these two indices with any frequency was surrounding the turn of the market in 2000. Back then you might remember it was the height of the “dot.com” mania. Below are two charts supplied by Bespoke Investment Group. These charts show a topping pattern for the NASDAQ and DJIA. What is remarkable here is that when we see this “gap” we tend to see the NASDAQ Composite enter a period of sub-performance, ceding leadership.

Days when DJIA or Nasdaq was down 2%+ and Dow UpSource: Bespoke Investment Group

Looking at the “gap” another way, we would point out that during the “dot.com” bubble, valuations on companies that had no profits (but had lots of promises) rose to historic levels. We believe that this may be happening again. Please note the Goldman Sachs Non-Profitable Technology Index below to see the size and scope of the issue. The index has many of the names that Growth investors have learned to love, including a slew of popular names including social media companies, at-home exercise and online car buying companies to name a few. Ultimately, however, markets tend to respect actual profits over promises to determine valuation.

Goldman Sachs Non-Profitable Technology IndexSource: Bloomberg & Goldman Sachs | Past performance is not indicative of future results.

Many prognosticators believe that the selloff in the “go-go growth” names has been triggered by a rise in long-term interest rates. It is true that higher interest rates dampen market valuation expectations for equities selling at the highest valuations. So, higher interest rates are not good for Growth stock valuations. Some speculate this will draw the Federal Reserve’s attention and they may attempt to limit the rise of long-dated interest rates.  We do not agree however that the Fed is concerned about the rising level of long-term interest rates. The Fed has assured us that they seek to support a robust rebound in the U.S. economy. Economic growth tends to support higher longer-term interest rates. We think the Fed is a fan of higher longer-term interest rates brought about by economic growth. The Fed has also bent over backward to assure the markets that much higher inflation will be tolerated in order to push the long-term inflation average to over 2%. We believe the speed of the creep of higher long-term rates is more important than the absolute level. We see higher rates as being welcomed by the Fed if it is coincident with economic growth. Do higher interest rates tend to favor cyclical stocks? Absolutely, IF the higher rates are accompanied by economic growth.

Our partners at Todd Asset Management have also noted the similarity between 2021 and 2000. They point out that during the 1990’s tech leadership, valuations became quite stretched. During the same period Value stocks got trounced. The recession of 2000 began a period of unwinding of those valuations and the beginning of a decade-long outperformance of Value stocks. They believe that conditions now are very similar to those in 2000, and we may see a repeat performance of Value over Growth stocks.

Russell 1000 growth vs Russell 1000 value relative performance

So, when we say “mind the gap” we are simply saying that rare market divergences like we are beginning to see should be noted by investors. We are not saying this market is on the precipice of a major bear market. We suggest that euphoria is likely here in the highly valued names that might find themselves in the chart above. What equities did well after the “dot.com” top? It was the deep cyclicals that included financials, materials, industrials, and commodities. Maybe it is time to begin to adjust your asset allocation dial? We think so.

CRN: 2021-0304-9001 R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.


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