While America seems to be muddling through the dumpster fire that is 2020, stocks could care less and seem to be anticipating the vaunted V-shapes recovery that many had high hopes for at the beginning of the pandemic.

If you were to tune into the nightly news, you may think the country is at a standstill or that we are all grabbing bread out of our recently looted grocery store, tip toeing through the broken glass and scattered fires to return home and shelter in place. Wall Street doesn’t care about social justice as Jim Cramer noted recently. It also has thousands of market watchers and analysts keeping track of day to day business of thousands of companies across the country who know that despite the headlines, business is continuing and sentiment is improving from the lows of March.

To prove Cramer’s point, while people were on lockdown worrying themselves sick or out protesting the murder of George Floyd, the S&P 500 had it’s best 50 day rally in history.

There are those calling this the most hated rally in history, and they may have a point. Big business by the looks of it seems to be doing well, while a large portion of the population is either unemployed, on some form of lockdown or out protesting. If you go a little deeper though, there are some nuances to this recent rally which still leave the door wide open in a number of different sectors to capture some great returns if the recovery we are seemingly in seems to gain momentum.

Before I get into that, it is worth pointing out that saving, investing and spending smartly is one of the strongest forms of social change and self empowerment that people can enact. People and governments take note, even when it doesn’t concern them directly, when money is held back or spent elsewhere. In the finance community, we often try to sidestep or look away from social issues and view money as neutral ground where we all share the ideal of doing better for ourselves. This however, defies the truth that money confers power, and one of the ways to empower disenfranchised people is through knowledge of the tools and habits which enable them to make themselves wealthy. So while it may seem callous to some to talk about money when there is so much more going on, it’s important to keep these things in mind and know that there are those that have a vision for the dignity we can each achieve by taking control of our own financial lives.

What are the Rich Doing?

As I have pointed out in past posts, the top 10% of households by wealth own about 80% of the value of the stock market. One of the aims of this blog is to demystify the stock market and investing for investors that may have lower levels of wealth and make the same mindset and information the rich have available to all. The rich may not all be worth emulating, except for when it comes to their money. So it pays to understand what they are doing and how they are preparing to either fall back from the market or take advantage of what they see as an opportunity.

I recently listened in on a call with a large wealth manager who performed a survey among their high net worth clients with assets of $5 million or more. The statistics were telling of where they think the market is headed and how they feel about the prospects for the economy.

• 70% of high net worth households are not going to alter their portfolios
• Only 6% plan to decrease their investments
• 23% of their portfolios are in cash or liquid investments
• 24% plan to increase investments in the coming months

So the overall message is that they are confident in their investments and sticking it out, they have cash to invest in opportunities and many are ready to put their cash to work. With so much cash still sitting on the sidelines, it’s worth asking the question of where to go now? In the depths of March, it really wasn’t apparent where things were headed in the next few months, and many have speculated that we could be in the midst of a bear market rally.

We could be or we could not be, the key thing to know is that no one really knows what could happen next, no matter how much confidence they say it with. The markets tend to not only have surprises to the downside but also the upside and that is exactly what we have seen recently. Take note though, that the responses of the wealthy I highlighted above convey that they long ago have prepped their portfolios to withstand any type of market and you should too. The question now is are there still opportunities given the recent rally and current valuations?

Breaking Down the Current Rally

We have essentially experienced an external shock to the economy and trade through the lockdowns. This produced a fall in economic activity and a rise in unemployment which has sapped demand. Lockdowns however, seem to be easing and slowly but surely, the economy seems to be cautiously picking up steam while at the same time shifting to the new reality.

The work from home phenomenon has benefitted the FAANG stocks and the large cap names which have seen a 40% rally since the March 23 bottom. I think most of us understand why this is. Large tech companies have been able to expand their business and take advantage of the crisis rather than suffer from it. Amazon, Microsoft, Google and Facebook are all able to have essentially their entire staff work from home while those of us stuck at home are even more dependent on their services to keep the wheels of daily life turning. It’s the businesses that require the physical presence of people that really suffered.

This was shown with the drop in commodity, transport and real estate shares compared to other sectors, while large cap growth has rallied.

Smaller companies, which cannot necessarily offer the scale and almost zero physical presence of the larger growth companies, have been hit harder and have not had as strong a comeback. Looking at the Russel 2000 which has a larger representation of mid and small cap companies in it compared to the S&P 500 shows this underperformance.

Different parts of the economic cycle produce rallies in different parts of the market though and it’s worth noting the facts which could propel mid caps to catch up in the near future:

• As the country reopens, many physical companies will begin to resume or ramp up operations.
• Mid cap companies are large enough to take advantage of low rates via the bond market as well as the PPP program whereas some small cap companies may struggle in this respect.
• If you think that we are now in the early recovery part of the cycle, mid caps tend to start to outperform at these times.

Ways to play the general mid cap sector include the Vanguard mid cap ETF (VO) and the SPDR S&P Midcap 400 ETF (MDY).

Additional Sectors to Consider

MLP’s – Believing that we are early cycle would also tell us that it is time to take a look at cyclical stocks. Who has been the big winner sector wise since the March 23rd low? It’s MLP’s which have risen 83% since that time. With generous, tax advantaged high yields, there are likely still gains to be seen. The Alerian MLP ETF (AMLP) currently yields over 6% while offering the upside of increasing flows through its pipelines as activity picks back up.

Oil – Investors were trying to speculate on the bottom of the oil market in April and many were burned by the United States Oil Fund (USO) which doesn’t hold oil but rather 1 month futures contracts. Since the headlines faded away, the market has gone into contango which has helped the ETF rally over 60%.

Industrials – Industrials were hammered by the downturn. So much so that there hasn’t been a downturn this severe in the Institute for Supply Management (ISM) Nee Orders Index in the last 20 years. This figure closely tracks the ratio of the S&P Industrials to the S&P 500 as can be seen below.

If the rally continues, we can likely expect a sharp jump in the index as we saw in 2009. This can be played by purchasing the Vanguard Industrials ETF (VIS).

Others – European financials have been seeing a quiet rally from their dismal lows as well as the US financials, which have seen a rally in the last 2 weeks. Bank of America (BAC) has seen a 28% rally since its recent lows on May 13th but is still way off the highs it saw in the $35 range pre Covid. Materials are also positioned to do well and offer a hedge for inflation. The Vanguard Materials ETF (VAW) is up 54% since its March lows.

As you can see, although the rally has been strong and fast, there are a number of sectors that still look attractive. Take advantage of this early cycle rally if you think it has legs and don’t forget to do your research before investing in anything new or that you don’t fully understand.

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