AGF CEO explains why dynamics driven by tech-sector clout, COVID-19, and self-directed investors create recipe for uncertainty
Recently, the exciting rally in equity markets hit a snag notably characterized by a hit to technology stocks. For some bullish investors, that might have been just an air pocket on an otherwise smooth upward flight, but AGF’s CEO and chief investment officer has suggested that it’s a cue to take more caution.
In a recent blog post, Kevin McCreadie highlighted the open secret that the stock market’s comeback from the depths of March has been propelled by the vast outperformance of a handful of big tech names in the U.S. The economic lockdown induced by the COVID-19 outbreak, he said, has fuelled the disparity as most technology companies reaped benefits at the expense of many other sectors.
“But as the recovery begins to take hold—albeit tenuously—investors are starting to wonder whether the growth rates of some tech companies can stay on pace,” McCreadie said, noting extreme valuations that may prove difficult to support moving forward.
As an example, he pointed to businesses whose services include video conferencing or e-commerce solutions, which have been vital to let societies continue functioning even during the lockdown. “[W]hat happens to their revenue streams if life eventually picks up where it left off when the pandemic hit?” he said.
Tech-sector stocks, he added, could be hurt by ratcheted-up tensions between the U.S. and China that could compromise critical supply chains and end-market demand.
In a perfect world, a flattening in tech-sector growth stocks would be offset by a proportionate upswing to markets as beaten-down cyclical stocks are bid back up on the prospects of better economic conditions. But the sheer influence of tech stocks in cap-weighted indexes, McCreadie said, could make investor portfolios that are “over-indexed” toward benchmarks such as the S&P 500 more sensitive to tech’s swoons.
“At the same time, those whose portfolios are more reflective of equal-weighted indexes won’t be hit as hard and may benefit in greater proportion from a subsequent climb in cyclical names,” he said.
The market may not even rotate away from tech stocks in so neat a fashion, McCreadie added. Even assuming a stalled economic recovery and an elongation of the stay-at-home environment, he said tech stocks may still be due for a larger correction. On the other hand, he expected cyclical segments of the market to rebound in a prolonged and meaningful way only with surer signs of sustained economic recovery moving forward.
The massive increase in self-directed retail investors over the past few months creates additional complications. One important question, McCreadie said, is whether a selloff in the names they loaded up on would make them run for the stock-market exits, or just push them to look for new opportunities to put their money in.
Many of the catalysts underpinning the equity-market rally have already been fully priced in, he said, particularly as the approval of a vaccine looks to come later this year or early in 2021. But in the shorter term, there are risks of a second COVID-19 wave as schools reopen and case counts rise in several countries. While future unveilings of economic data like third-quarter GDP could surprise to the upside, the arrival of significant new stimulus measures is increasingly in doubt, notwithstanding the months of discussions surrounding plans for such added support.
“Then, of course, there’s the looming U.S. election that may end up being the biggest risk of all,” McCreadie said. “Investors need to be ready for the possibility of a disputed result that upends markets and further fuels the country’s deepening social divide.”
Given all those balls in the air, markets “may be in for a stretch of muted returns offset by minor pullbacks,” McCreadie said. “Equities may experience significant day-to-day volatility and remain range-bound until clarity on these issues—and how they are resolved—becomes apparent.”
