The Great Rotation

"The best measure of innovation is change in human behavior." - Stuart Butterfield, Founder of Flickr & Slack.


The most interesting developments of the last month had nothing to do with the election. It's very simple and you might have missed it, but it's there.


What's been working well in equity markets hasn't worked as well over the past month.


What hasn't been working in equity markets has started to work.


Source: YCharts


The above graph shows performance for the NASDAQ (purple) vs. three S&P sectors that have been deeply out of favor (financials, industrials, and energy) as of 10/1/20.


Source: YCharts


The above graph shows performance for the NASDAQ (purple) vs. two small cap ETFs as of 10/1/20. Small cap stocks have dramatically trailed large cap stocks (including technology stocks) over the past 3, 5, and 10-year periods.


Why were investors suddenly interested in beaten down areas of the market?


One theory is that people are tired of isolating and have started to move about. The below mobility index would support that hypothesis:

Source: Bespoke Investment Group


The above graphic shows data from traffic congestion, air travel, petroleum demand, and cell phones to track human mobility. Although we aren't yet at pre-COVID levels, people are starting to move around.


If people are moving around more, it certainly would bode well for old economy stocks.


People need to fill their gas tanks.


Work from an office might require new business attire.


Travelers book airline seats, need a hotel room, and dinner reservations.


You get the picture.


If equity markets were sniffing out a return to normalcy, the shift got a shot in the arm (pun intended). On 11/9, it was announced that Pfizer's COVID-19 vaccine proved ~90% effective during the last stage of clinical trials.


The market action was insane...


Source: YCharts


The above dot plot shows S&P 500 performance (every dot is an unnamed company) for 11/9 (bottom, x-axis) and year-to-date (left, y-axis). You can see the worst performing stocks YTD (bottom right grey area) had HUGE gains on 11/9.


Source: YCharts


The above shows the top performing S&P 500 stocks from 11/9. The list is dominated by real estate (REITs), energy, travel, leisure, etc. Notice the huge gap between 11/9 performance and YTD performance!


Conversely, stocks for a COVID economy went the other way...


Source: YCharts


The above shows the worst performing S&P 500 stocks from 11/9. The list is littered with beneficiaries of work from home, technology, social distancing, etc. The action on 11/9 would support our thesis that COVID has been a brisk tailwind to technology stocks.


We aren't proclaiming that old economy stocks are back and technology is going into the dumpster, but we feel there are a few important lessons that can be learned rom the reversal.


1. Humans are quick to declare extreme endings. The end of offices. The end of brick and mortar retail. The end of airline travel. Will human behavior change due to the pandemic? Probably.


Post COVID, are we never going to work in offices again, enjoy our favorite restaurant, or travel to our favorite vacation spot? Probably not.


2. It’s completely normal if part of your portfolio isn’t working. I would find it alarming if everything is working perfectly at the same time.


It's surprising how many people want to sell something because it was out of favor for six months.

3. It's impossible to predict what the best performing asset class, sector, country, stock is going to be from year to year. Quite often, the best performing asset class one year can be the worst in following years (the opposite is also true). It's not easy to trim what’s working and buy an asset class that's not working, but that’s completely rational behavior.


Source: Nobel Investor


The above graphic shows performance for various asset classes from 2010 to June 2020. The top performing asset class year to year resembles randomness rather than a predictable pattern.


4. Performance can change quickly. One day, you're a genius. The next, you feel like an idiot. Avoid the extremes, i.e. "tech stocks will go up forever," or, "energy and industrial stocks are worthless."


Someone recently asked me what I'm watching in financial markets. My answer was simple...


Things that work no longer work as well.

Things that haven't worked, start to work.

Markets move in cycles. Things go in and out of favor.


In the late 1990s technology stocks were the rage.


The 2000s emerging markets crushed


In the mid 2000s, it was anything tied to housing.


Now it's big technology stocks.


We haven't a clue if this rotation from what's worked to what hasn't worked is a blip in the radar or long-term trend. The truth is likely somewhere in-between.


Like our friend David Howitt, author of "Heed Your Call," would say, embrace the power of And. There's room in your portfolio for technology and old economy stocks.

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