1. We expect the next phase of the economic recovery to be more difficult, which may favor companies that can grow without much help from the economy, such as growth stocks.
2. The earnings outlook for the growth style is far better. Russell 1000 Growth Index earnings are expected to fall only 7% in 2020, compared to 32% for the Russell 1000 Value index. Growth index estimates for this year have been cut by 13 percentage points since March 31, compared to 28 percentage points for value (source: FactSet).
3. Stronger balance sheets of companies represented by growth-style stocks should warrant a premium in a recessionary environment, in our view. (This view also supports our preference for large caps over small caps.)
4. Stay-at-home trends probably will not reverse fully anytime soon. The growth-oriented sectors, including communication services and technology, are well positioned for the current environment.
5. The interest-rate environment may likely remain challenging for financials, the biggest value sector, well into 2021, in our view, and consistent with recent communications from the Federal Reserve.
As a stronger and more durable economic recovery becomes evident, we think value will have its day. At that point, we would expect better performance for small caps and the cyclical value stocks found in the financials and industrials sectors. However, right now we think it’s too early.
Tactical Views Unchanged
Our year-end 2020 fair value target range for the S&P 500 remains 3,150–3,200. To get to this number, we use a price-to-earnings ratio (PE) of about 19 and a normalized earnings figure of $165. An annual earnings run rate like that may not be achievable until late 2021 and early 2022. With interest rates so low, the potential for a vaccine during that time frame, and support from massive stimulus, we are comfortable using a longer-term earnings target to value stocks. For long-term investors, we find stocks more attractive than bonds at current valuations and recommend overweight allocations, and a corresponding underweight to fixed income for suitable investors.
Jeff Buchbinder is an equity strategist for LPL Financial.