Since the market topped on February 16th, the current correction is a very different experience depending on if one’s style of investing (value or growth). While the S&P500 only dipped 5.6% and is currently at new highs, the tech-heavy NASDAQ100 dipped 12% from peak to trough, and is still 7% from new highs. After value has underperformed for years, we are finally seeing a meaningful rotation out of tech and into beaten down value names.
The story on the rotation has to do with the quick rise in the US 10-year treasury yield. There are many reasons why bonds are being sold off, which inversely pushes up yields – inflation pressure has the bond market believing the FED will have to raise rates, which would likely stop this economic expansion. Also, the amount of fiscal debt written since the pandemic is creating a glut of supply, which the FED will likely not be able to fully absorb and this will put pressure on rates
Regardless, since many high growth stocks are projecting positive cash flow into the future, higher yields on longer duration bonds will affect future cash flows, causing a reset of current valuations. While the speed of the rise is unusual and unnerving to some investors, it is important to zoom out to gain some perspective on the recent move in yields.
As we can see above, the US 10-year treasury yield is still at historically low levels. In the chart above, bear markets are highlighted in gray. Going back to 1970, we have never seen a bear market begin with a US 10-year treasury yield below 3%. Our current rate is around 1.75%.
Further assurance comes directly from the Fed Chair, Jerome Powell, when he recently said the Fed expects to observe a momentary bump in inflation in March and April as the $1,400 stimulus checks shows up in economic data, but that they are not concerned about inflation rising above their 2.5% tolerance threshold. If inflation start to rise more than expected, Fed officials believe they have the tools to control it.
The Fed further claimed that they will be able to control inflation and has stated they will want to see maximum employment before changing their policy. This suggests it could be at least 2023 before we see major policy changes from the Fed, which is in line with the timeline they have outwardly discussed.
What’s Next?
With numerous microtrends in play, and recent earrings reports confirming or even raising future guidance, we view this correction in tech stocks as normal and temporary. We believe central banks are and will continue with an accommodative monetary policy for the foreseeable future. Corrections in growth stocks are not uncommon or unusual, no matter how painful they may be. A short-term price correction does not ultimately affect the underlying businesses of the stocks that we own.
In 2019, we saw a similar correction in tech growth. That year, the focus was on cloud pure plays, where the popular narrative at the time was stressing the overvalued cloud stocks as the neo-bubble stocks. While the S&P500 dipped 6.6%, and quickly recovered, many names like Twilio, Zoom, Fastly, Shopify, Okta, etc. saw corrections between 30-50%.
Our portfolio is geared towards taking advantage of powerful, long-lasting industry microtrends that will shape future generations. It is therefore illogical to stress over daily price movements in these innovative companies.
Growth Vs. Value and the NASDAQ100
Since the current secular bull market began in March of 2009, there is not an extended period of time where value has outperformed growth. This has been a growth driven bull market, with tech leading the way.
Even since the March low in 2020, tech has continued this trend. After the pandemic shutdown, many tech names saw outsized growth due to ongoing microtrends, while others saw a bump due to a stay-at-home economy leaning heavier on tech for support. Many of the value names were hit exceptionally hard, further widening this gap. With valuations stretched in the tech sector, rates on the rise and the economy opening up, we are starting to see a real value rotation.
As the chart above shows, the 14% Gap between Tech Growth and Value has nearly closed. In fact, while many growth names are down, much like the cloud names in 2019, value stock in the same timeframe are actually up.
We view this rotation as a positive sign for the overall market. We need all sectors participating in a bull market for it to remain healthy. Furthermore, we do not believe this market will continue with value leading the charge. There are simply to many exciting and profitable microtrends unfolding in tech, which we do not see ending anytime soon. Instead, we view this moment as an opportunity.
We have been focusing on the NASDAQ100 for several reasons. For one, it is predominantly tech focused. Also, it has been leading this bull market, and for the market to continue higher, we don’t see that being possible without the NASDAQ100. We really need it to join the other major indexes to new highs before we can count this correction as being over.
In short, if the NASDAQ100 can break above last Wednesday’s high at 13300, the probability increases that the low is in for this growth selloff. However, if we fail to break above this level, we could see another leg lower before we can write this correction off.
With the NASDAQ100 showing a negative RSI reversal signal, coupled with many charts we track whose current corrections appear to be incomplete, we may add hedges going into next week. We are 3% from the 13300 breakout, and about 10% from our downside target, if the NASDAQ100 cannot breakout above the 13300 region. This is the type of risk/reward we are willing to take for a hedge, if this final leg lower does unfold.
Relative Strength
Regardless, if we breakout and continue up, or need one final leg lower, we do not believe this bull market is over yet, and that this drawdown has provided some fantastic opportunities. In periods of market weakness, it is important to look at areas of strength. The future leaders tend to be stocks that go down less than their peers, bottom first, and lead out of a correction. That being said, the bounce off the March 5th low has provided some clues on where who might lead the next leg higher.
As the above chart shows, to lump all of tech into one category would be a mistake. Even though the S&P500 Tech Sector is showing poor relative strength in the chart above this year, as well as from the March 5th bottom, it’s important to identify what dominates that sector. Being a market cap weighted index, Apple and Microsoft makes up over 40% of the index, so it is heavily influenced by big tech.
If we dive into other microtrends within tech, there are a handful of sectors that are showing strong relative strength, even in light of the tech sell-off. What interests us are the sectors that are showing the most strength since the March 5th bottom.
Bitcoin/Crypto Currencies
The number one performer since March 5th is bitcoin/cryptos, and the businesses around this microtrend. Bitcoin is up over 58% YTD, and more notable is that it has continued its strength since the March 5th bottom. Bitcoin is our largest position, and though we are forecasting a bout of weakness in the near future, we do believe the uptrend will ultimately continue into 2022.
However, there are several businesses that benefit from the crypto market, such as Square, Silvergate Capital, eToro, Coinbase, Voyager Digital, just to name a few. We currently own Voyager Digital (VYGVF), which is a crypto exchange as well as a fintech company.
After being up over 500% YTD, we believe Voyager’s best days are ahead of it. It’s also the leader of the group just mentioned in terms of projected forward growth. If Voyager Digital continues with the revenue it already posted in February at $20 million per month, the valuation below will be cut in half.
China Tech and Green Energy
Another trend we have seen since the March 5th bounce is green tech and Chinese tech. In fact, they rank as the #2 and #3 micro sectors within tech since the March 5th bottom.
This falls in line with one of our favorite tends in 2021 – Chinese EVs. XPeng has been in a large downtrend, which we have thoroughly tracked and bought into along the way. Since the March 5th bottom, XPEV has bounced as much as 48%, showing outstanding relative strength. Nio has also bounced as much as 38% from the bottom. We used this bout of weakness in Nio to begin our position. Even if we do see another leg lower in the market, the reaction from March 5th further confirms the opportunity we see in the Chinese EV market in 2021, which we will continue to target.
You can read Beth’s analysis on XPEV and NIO here and here.
OTT/CTV Ads
Finally, OTT/CTV Ads has also shown considerable relative strength since the March 5th bottom. Going into 2021, it was one of our biggest convictions and we allocated our portfolio accordingly. This micro sector has been considerably strong YTD, outperforming all major sectors in the broad market, short of beaten down energy stocks. It currently ranks #4 in terms of strength since the March 5th bottom, suggesting that this trend still has more room to run.
We currently own Roku, Magnite, Fubo within this trend. Even after a considerable drawdown in these names, they are still showing outperformance against the NASDAQ100.
Stocks on our Radar that are Showing Solid Relative Strength
Two more stocks that made news from a relative strength perspective include UPST and VUZI. UPST recently raised 2021 revenue guidance by over 50% and the stock roared higher, while VUZI stock also reacted very positively to its earnings beat.
Conclusion
We do not believe that this is the end for tech leadership in the bull market. There simply too many important microtrends at play, and more about to go online. This rotation is healthy. We want as many stocks and sectors participating in the bull market, which is typically what we see going into the strongest leg of a bull market.
We believe this correction has provided a fantastic opportunity to buy shares of out-of-favor tech names, which we do not believe will stay out of favor for long. The relative strength in certain micro sectors is telling us what areas will likely lead into the next leg up, and we are pleased to see that they are lining up with Beth’s 2021 thesis so far.