Category Archives: Indices

Thematics Make Outsized Returns in 2020

Thematics Make Outsized Returns in 2020

To say 2020 was a year unlike any other is an understatement on several fronts but despite all of it, equities finished the year higher and once again the major indices were bested by several of Tematica Research’s thematic indices. That includes several of them topping the outsized (but fairly narrowly driven) 43.6% return for 2020 registered by the Nasdaq Composite Index.

Investing between February 19th and March 23rd was a clear example of “catching a falling knife” as the uncertainty of the impact of an unfolding global pandemic set in. While that uncertainty lingered well into the 2nd quarter, some trends started to emerge that forced changes in both consumer behavior and company business models. Going into the 3rd quarter, equities recovered as economic data and earnings were somewhere between better than expected and not as bad a feared. There were some setbacks in September and October as Covid case counts surged, but stocks were once again surging in early November due to a fresh shot of hopium following positive vaccine developments and the conclusion of the presidential election. 

The bulk of the 2020 gains for the Dow Jones Industrial Average and the S&P 500 came during the fourth quarter, despite the year-end haggling over the pandemic relief bill. The same was true with the small-cap heavy Russell 2000, which climbed 31% in the fourth quarter, outpacing the other major market barometers and enabled its positive return for all of 2020. By comparison, the Nasdaq Composite Index, which closed up more than 40% in 2020, benefited from a number of factors, including the pandemic inspired accelerated shift to digital shopping, work from home and learn from home. That pull-forward in both data consumption and data creation fueled incremental network capacity additions and set up the launch of 5G networks and devices in the second half of the year. The same shift, however, led to a year over year uptick in cyberattacks culminating with the Solar Winds attacks that compromised not just federal institutions and large companies, but also platforms of Microsoft (MSFT) and FireEye (FEYE). Those catalysts in particular led to the strong December quarter showing for Tematica’s Digital Infrastructure & Connectivity and Cybersecurity & Data Privacy investing themes.

What’s to come in 2021?

It’s great to enjoy the wins, but as we all know, the stock market is a forward-looking animal and that means not taking too much time to pat ourselves on the back, but rather preparing for what lies ahead. Even as the COVID-19 vaccine is being administered, it will take months before vaccines are readily available to all who need them. Then, and only then will many politicians feel comfortable fully reopening their economies. On January 4, for example, UK Prime Minister Boris Johnson just ordered a third national lockdown to be in place through mid-February. Yes, there is a light at the end of the tunnel, but we continue to see some economic speed bumps to be had — at least at the outset of the March quarter. 

In the coming weeks, President-elect Joe Biden will be sworn into office, and despite the lawsuits, promises of legislative (and other) disruptions, the machinery of government continues to move forward. Perhaps Capitol Hill will hammer out an infrastructure spending bill that will finally address the nation’s crumbling roads, bridges, ports, airports and highways. The ongoing trade issues with China will also need to be addressed, as well as President Biden’s own agenda items.

Before Biden takes the Oval Office, two known items that we’ll contend with are the CES 2021 tech conference and the start of the December-quarter earnings season. Much like other conferences and trade shows held during the pandemic, CES will be a virtual-only event for the first time in its history. It will still feature a number of keynotes that will prognosticate on what we are likely to expect in the coming year on the technology front and “virtual” vendor booths.  

In recent weeks we’ve seen GDP expectations for the start of 2021 drift lower as the pandemic has once again presented a headwind to the economy and efforts to contain it have expanded. We’re also learning of a new strain of Covid-19 that “spreads more efficiently” but “does not seem to evade the protection that’s afforded by vaccines that are currently being used,” according to Dr. Anthony Fauci. At the same time, the distribution of vaccines in the U.S. has gotten off to a slower-than-expected start. Expectations are that vaccine activity will increase in the coming weeks and we’ll be sure to keep tabs on vaccine-related data published on the CDC COVID Data Tracker website. As the number inoculated rises in the coming months, the closer we will be to the economy returning to normal. 

The issue is it will take some time to walk down this path, which to suggests things won’t begin to normalize until the second half of 2021. We also continue to think consensus expectations run the risk of an economic and earnings speed bump in 2021. Supporting that view is the retreat in the Citibank Economic Surprise Index in recent months, and also the slowing growth reported in the IHS Markit December Flash U.S. Composite PMI data. Part of that was due to the fall in new export sales, as renewed lockdowns in key export markets dampened foreign demand.

All of this is summed up rather well by Chris Williamson, Chief Business Economist at IHS Markit who said, “… December has seen companies rein in their expectations, given the higher virus case numbers and tougher lockdown stances adopted in some states. Lockdowns in other countries were meanwhile reported to have hit exports. While vaccine developments mean some of the clouds caused by the pandemic should lift as we head through 2021, rising case numbers continue to darken the near-term outlook.” 

Normally, there tends to be some step down in economic activity from the December quarter to the March one, as consumer spending wanes in comparison to the year-end holiday shopping season. The start of 2021 is expected to see a somewhat larger step down in GDP — to 1.9% during the March quarter vs. the expected 4.1% in the December 2020 quarter, according to data published by The Wall Street Journal’s Economic Forecasting Survey. That same survey goes on to forecast GDP of 3.7% for all of 2021, which means its expectation for the other three quarters of 2021 hover around 4.0%. 

While recent COVID-19 new cases have waned some in aggregate across the U.S., hot spots remain — and that has prompted the extension of virus-fighting measures even as a new strain of the virus that spreads quicker has been found inside the U.S. Similar to what we saw after Thanksgiving, odds are we will see a post-holiday rise in new case counts in early January. Should this come to pass, in all likelihood it will mean more restrictions that will be a headwind to the economy and corporate earnings.

Earnings expectations ahead

On the December-quarter earnings front, data from FactSet shows that so far in the quarter, more S&P 500 companies issued positive earnings guidance than average. More than 80 companies in the index have issued EPS guidance for the December quarter so far and of them, roughly 30 issued negative EPS guidance and more than 55 issued positive EPS guidance. That puts the percentage of companies issuing positive EPS guidance at more than 65%, well above the five-year average of 33%. This sounds positive, but keep in mind that the total number of companies issuing guidance remains well below the five- year average for the quarter and consensus expectation for December quarter EPS is still a year-over-year decline of around 10%.

Digging into the data, we see the S&P sectors that are driving that year-over-year decline for the December quarter.

But again, the stock market is a forward-looking animal, and current expectations call for a 22.7% rebound in S&P 500 EPS during 2021 vs. 2020, as well as a 4.1% increase compared to 2019.

Circling back to the Tematica Research indices that we shared at the outset, their EPS prospects over the 2019-2021 period are multiples greater than for the S&P 500. We attribute this to the pronounced tailwinds that are powering both each of those themes as well as the revenue, EPS and cash flow of the aggregated constituents. One rule of thumb on Wall Street is that faster EPS growth tends to spur multiple expansion, which is a pretty powerful one-two combination for stock prices and index constituents. Reflecting on the below data, it looks like 2021 will be another year of outperformance for several Tematica Research themes and indices.

Sizing up thematic returns in February

Sizing up thematic returns in February

Equities continued to swoon during February as investors came to grips with the expanding impact of the coronavirus. Amid a growing sea of corporate warnings that led investors to question earnings forecasts for the current quarter as well as all of 2020, all the major stock market indices finished February down 6.4%-10.1%. The hardest hit was the Dow Jones Industrial Average, and the US stock market barometer that is the S&P 500 fell 8.4% in February, which added meaningfully to its decline year to date. 

Despite investors taking profits in the Technology and Healthcare sectors, they along with Communication Services helped temper the market’s February selloff. Names like Regeneron Pharmaceuticals (REGN), Biogen (BIIB) and Gilead Sciences (GILD) saw gains on advances in potential coronavirus treatment development in particular. While markets overall were impacted by unfolding events during the month Energy, Utilities and Consumer Discretionary names seemed to lead the way down. Muted demand for oil due to reduced manufacturing activity and fears of continued softening in the global economy saw oil prices drop almost 17% during the last week of the month. Unsurprisingly, cruise line operators Norwegian Cruise Lines (NCLH) and Caribbean Cruise Lines (RCL) were among the worst performers this month both posting losses over 30% with Carnival Corporation (CCL) not too far behind losing over 23% of its market value as those companies paired back 2020 expectations due to the coronavirus’s impact. The same was had with airlines with American Airlines Group (AAL) down 29.68% and Alaska Air Group (ALK) off 21.88% as they too canceled flights and reduced schedules owing to the virus.  

At Tematica we’ve often questioned the notion of the S&P 500’s construction as well as the ability of an 11-sector framework to accurately capture the evolving landscapes that we and other investors find ourselves confronting as structural changes associated with our 10 investment themes continue to unfold.  In our view a different perspective is needed, a thematic one, to properly identify those companies at the forefront of these unfolding structural changes. For example, cruise lines such as the ones mentioned above fall into the Consumer Discretionary sector while companies such as Omega Healthcare Investors (OHI) that offer long-term healthcare facilities is classified as Real Estate even though both are feeling the tailwinds of Tematica’s Aging Population investing theme on their respective businesses.

Another example of looking at the world thematically is found in the Tematica Research Cleaner Living Index, which focuses on the shifting consumer preference for cleaner products and services that are better for you, your body, your work, your workplace, and the environment.  Despite sharp February sell-offs in several index constituents, including Acuity Brands (AYI). Fresh Del Monte Produce (FDP) and Hain Celestial (HAIN), solar energy systems companies Sunrun (RUN) and SolarEdge Technologies ((SEDG), as well as plant-based alternative Beyond Meat (BYND) and Tesla (TSLA), led the Cleaner Index to slip by only 3.1% in February. That decline more than offset the index’s modest rise posted during January leaving it down 2.6% year to date vs. the S&P’s 8.6% drop at the end of February. 

Of note during February, 

  • Plant-based meat alternatives notched another win as Beyond Meat announced the Beyond Meat sandwich will be available at Starbucks’ (SBUX) nearly 1,200 coffee shops across Canada on March 3. The sandwich will include cheddar cheese and egg on an artisanal bun. Not to be outdone, Impossible Foods announced its plant-based meats will be available across Walt Disney (DIS) theme parks and cruise lines come Feb. 28. 
  • Confirming the drivers for Cleaner Living are global, during February it was reported by the Fraunhofer Institute for Solar Energy Systems (ISE) that 61.2% of Germany’s net public electricity generation was from renewable sources, marking a new monthly record. 
  • And while Tesla has an early lead in the electric vehicle space, BMW is set to take the wrap off its i4 electric concept car and General Motors (GM) is slated to discuss its electric vehicle and battery strategies at its upcoming EV Day on March 4. GM’s battery facing comments will be ones to watch ahead of Tesla’s “Battery Day” slated for April.

Amid the coronavirus headlines investors were digesting during February, there were two powerful reminders of the growing need for cybersecurity and digital privacy solutions. The first was the announcement from gaming and hospitality giant MGM Resorts International (MGM) that it had been the victim of a data breach in 2019. The second was a statement from the US State Department blaming the Russian military intelligence agency known as the GRU for the cyberattacks that hit Georgia last October and disrupted “several thousand Georgian government and privately-run websites and interrupted the broadcast of at least two major television stations.”

Those attacks are but the latest high-profile ones to be reported and point to the increasing need for companies, governments, other institutions and individuals to protect their data, especially as the regulatory environment could increase the frequency of financially motivated cyber-attacks. Each week in Thematic Reads, we share some of the latest headlines and news stories surrounding the Foxberry Tematica Research Cybersecurity and Data Privacy Index. As society becomes increasingly connected as part of our Digital Lifestyle investment theme and as new technologies associated with our Digital Infrastructure investing theme look to connect more devices than ever before, we continue to see an increasing demand profile for the constituents that comprise the Foxberry Tematica Research Cybersecurity & Data Privacy Index. During February the index fell 8.2% as gains registered in the shares of Cloudflare (NET), Norton Lifelock (NLOK) and ForeScout Technologies (FSCT) were offset by declines in Palo Alto Networks (PANW), Globalscape (GSB) and Mimecast (MIME) shares. 

Turning to the Tematica’s Thematic Dividend All-Stars Index, which is comprised companies with at least ten consecutive years of increasing annual regular dividend payments and whose business models will benefit from multiple thematic tailwinds tracked by Tematica’s Thematic Scorecard, its total return for February was -8.1% vs. the total return for the S&P 500 of -8.3%. Among the index’s 65 constituents, only Healthcare Services Group (HCSG), Albemarle Corp. (ALB) and Target (TGT) finished higher in February, leaving meaningful declines at Aaron’s (AAN), Nu Skin (NUS) and Invesco (IVZ) to have a greater impact on this equally weighted index. 

Generally speaking, companies that continually increase their dividends to shareholders tend to see a positive step function higher in their share prices. During the first two months of 2020, just over 25% of the index constituents announced fresh dividend increases including Aaron’s (AAN), Analog Devices (ADI), Digital Realty Trust (DLR), Best Buy (BBY) and AT&T (T). Given the positive impact of tailwinds associated with Tematica’s investment themes, we look forward to sharing news of new dividend increases at the other 72% of the index constituents in the coming months.