Sector Leverage: Small Caps, Intl, Growth/Value

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Sector Leverage: Small Caps, Intl, Growth/Value

In our “Markets” section of our full report last night we reviewed how the S&P can rally another 12%: here in our “Data” section we want to expand the conversation to consider the upside leverage in US Small Cap stocks, Growth/Value investment styles, as well as EAFE and Emerging Market equities. The anchors of our bullish scenario for the 500 were Technology, Health Care, and three super cap disruptive tech companies (Google, Amazon and Facebook). Get those to work and everything else can basically tread water.

However, since every equity index we’ve just called out has its own idiosyncratic industry weights the analysis of what gets them moving higher is very different from the S&P 500. We’ll go through each in turn and give some brief comments on each one’s investment merits:

#1: Russell 2000 (US Small Caps):

  • Health Care has become more important to the Russell since February 5th (our pre-COVID benchmark day), with a 21.2% weighting now versus 18.0% then.
  • Financials are 16.3% of the Russell currently, with Industrials and Technology at 15.1% apiece. All are within 1.5 percentage points of where they were in early February.
  • The Russell is 26.2% lower than February 5th versus -15.4% for the S&P 500.

Upshot: the Russell looks nothing like the S&P 500 either in terms of sector concentrations or recent performance, and the first point explains the second. Not only does it obviously lack super-cap exposure, but its real leverage is to high yield spreads as a proxy for access to/cost of capital. With Federal Reserve interventions in that space, US small caps should do fine. But the fundamental drivers in this slice of the US equity market look nothing like large caps.

#2: MSCI EAFE (non-US developed economies) Equity Index:

  • Technology has just an 8% weighting here. The dominant groups are Financials (16%), Health Care (14%), Industrials (13%) and Consumer Staples (13%).
  • What little Technology sits here has actually been working quite well (SAP, 1% of the Index, only 12% off its February highs, ASML, also 1%, 9% off its highs). There just isn’t enough Tech in the EAFE Index.
  • MSCI EAFE is 19.3% off its February 5th levels versus 15.4% for the S&P 500.

Upshot: we continue to recommend avoiding EAFE equities, mostly because of that relative overweight to Financials. European banks are nowhere near as well capitalized as those in the US, and we believe the Continent will have a longer economic road back from the current crisis than the US.

#3: MSCI Emerging Markets:

  • This index is even more heavily concentrated in the top 3 holdings than the S&P 500, with 17.1% in Alibaba (6.9%), Tencent (5.7%) and Taiwan Semi (4.5%). Add in Samsung (3.8%) and you’re at 20.9%.
  • EM also has large exposure to China (37% weight), Taiwan (12%), and South Korea (11%), for a combined 60% of the index.
  • Financials are the largest sector weight, at 19%.
  • MSCI EM is off 17.6% from its February 5th levels versus 15.4% for the S&P 500.

Upshot: EM’s leverage is to export economies and China’s versions of US Big Tech. Our bias is to prefer the S&P 500 because its lower Financials exposure, but in terms of geographic diversification EM looks better to us than EAFE.

#4: US Growth Versus Value:

  • Top sectors in S&P 500 Growth: Technology (37%), Consumer Cyclicals (13%), Communications (13%)
  • Top sectors in S&P 500 Value: Heath Care (20%), Financials (19%), Consumer Staples (11%)
  • Growth is down 10.9% from February 5th, Value is down 19.5%
  • Top sectors in Russell 2000 Growth: Health Care (28%), Industrials (17%), Technology (17%)
  • Top sectors in Russell 2000 Value: Financials (25%), Industrials (12%) and Real Estate (12%)
  • Growth is 22.5% lower since February 5th, Value is -30.6%

Upshot: it’s not “Growth” that is trumping “Value”, it is Technology and Health Care as sectors that skew the performance results here. No surprise given everything we outlined in our “Markets” section, but we prefer Growth to Value.