10 stocks riding the rotation

Bruce Apted

State Street Global Advisors

The positive news regarding the effectiveness of both Pfizer and Moderna’s vaccines against Covid-19 are exceptionally good news for the world. With many more companies working in parallel we can likely expect more positive developments on these fronts in the coming months and over the course of 2021. While success is unlikely to occur in a straight line, the vaccine is a much needed light at the end of the pandemic tunnel. Equity markets have rallied on the news as you would expect but the real story lies beneath the surface. In this monthly note we take a closer look at the large rotation within equity markets.

Vaccine rally reverses many year to date trends

Since the latest positive vaccine developments were released to the market, we have seen the MSCI World Index rally to 7.43% and the S&P/ASX 300 Index has rallied 9.79%. We have seen a significant jump in some of the most beaten up stocks within the market. Figure 1 below lists the best performing stocks from the top 100 market capitalized stocks within the S&P/ASX 300 Index from Friday the 6th of November to Tuesday the 17th of November. Also noted alongside this performance has been the year to date (YTD) performance of these stocks.

Figure 1. Top ten stock performances post positive vaccine developments as at 17th November 2020

As shown in Figure 1 we have seen a reversal of fortunes for those companies that have been impacted the most. They are now the companies with the most to gain from a vaccine. From a sector perspective you can see that both Energy and REITs are the biggest beneficiaries of a vaccine as illustrated on both Figure 1 and 2.

Figure 2. Some of the worst performing sectors YTD have rallied the most on the positive vaccine news

The 2020 back story

During 2020 investors de-rated the companies that were the most impacted by the pandemic including Travel, Energy, Real Estate and Financials. In contrast investors positively re-rated the few companies expected to do better in the pandemic world. Examples included Information Technology, Health Care and some Consumer companies. Over the course of 2020 the gap between the Covid-19 winners and Covid-19 losers became extreme. The recent price reaction to the positive vaccine news partly reflects the extreme pricing caused by the pandemic.

As shown in Figure 2, Energy, REITS and Transport have outperformed the most on the vaccine news

while some of the best performing sectors like Information Technology, Healthcare, Gold and Consumer Discretionary underperformed the most. Iron ore and some of the Metals and Miners have managed to buck this trend outperforming both during the positive vaccine developments and YTD.

Figure 3 below outlines the returns associated with different groups of stocks during the vaccine rally. We group stocks by different characteristics and look at the return differences between these groups. During the period from the 6th November to the 17th November when the dominant news was the positive developments of the vaccine we observed a number of interesting rotations. The returns to these different stock characteristics are captured in Figure 3 below.

Figure 3. Quintile spread returns to various themes during the vaccine rally and rotation

Most of the relationships observed in the vaccine risk rally are atypical.

  • Companies that had performed the best YTD underperformed the most.
  • Companies with the great risk as measure by beta outperformed.
  • Companies with the worst YTD earnings revisions outperformed.
  • Companies with the lowest levels of profitability outperformed.
  • The only quality that was more typical was that companies that were cheaper outperformed.

The top 20% of stocks that outperformed on the vaccine news were up 22.6% from the 6th to the 17th of November and whilst this is impressive, remember this cohort is still down -12.5% YTD. Other than having positive returns during the positive vaccine news how might we characterise these stocks?

Figure 4: What are the key characteristics of the vaccine winners

The Vaccine beneficiary cohort can be characterised as;

  1. Higher risk with an average with beta of 1.5.
  2. Greater downgrades to earnings (-35%) in 2020.
  3. Lower quality in terms of gearing and lower levels of profitability.
  4. Slightly better value especially in terms of expected free cash flow yields.

The vaccine rally has many similarities to a classic junk rally.

In contrast we have stocks that on average have the opposite characteristics. The portfolio has exposure to companies which have had lower volatility, with improving earnings prospects, higher operating margins and which we believe offer better value (see Figure 5 below).

Figure 5: Key characteristics of the State Street Australian Equity Fund

The Bottom Line

The recent outperformance of the lower quality more distressed securities with higher volatility is atypical. Historically we find these bouts of outperformance are often short lived and hence we caution against over extrapolating this recent development. Over the longer term we prefer higher quality businesses with improving earnings prospects, higher operating margins and lower volatility. 

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Issued by State Street Global Advisors, Australia Services Limited (AFSL Number 274900, ABN 16 108 671 441) (“SSGA, ASL”). Registered office: Level 14, 420 George Street, Sydney, NSW 2000, Australia · Telephone: +612 9240-7600 · Web: ssga.com. State Street Global Advisors, Australia, Limited (AFSL Number 238276, ABN 42 003 914 225) (“SSGA Australia”) is the Investment Manager. References to the State Street Australian Equity Fund ("the Fund") in this communication are references to the managed investment scheme domiciled in Australia, promoted by SSGA Australia, in respect of which SSGA, ASL is the Responsible Entity. This general information has been prepared without taking into account your individual objectives, financial situation or needs and you should consider whether it is appropriate for you. You should seek professional advice and consider the product disclosure document, available at www.ssga.com, before deciding whether to acquire or continue to hold units in the Fund. Investing involves risk including the risk of loss of principal. Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions. The views expressed in this material are the views of Bruce Apted through the period ended 12 October 2020 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Past performance is not a reliable indicator of future performance. This material should not be considered a solicitation to apply for interests in the Fund and investors should obtain independent financial and other professional advice before making investment decisions. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA Australia’s express written consent. © 2020 State Street Corporation - All Rights Reserved 3279052.1.1.ANZ.RTL Exp. Date: 31/10/2021

Bruce Apted
Head of Portfolio Management – Australia, Active Quantitative Equity
State Street Global Advisors

Bruce is Head of Active Quantitative Equity - Australia, for State Street Global Advisors. He has over 20 years' experience, covering Australian and global equites, long and short equities as well as global macro strategies.

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