Five Macro Themes in Equity Markets to Watch Now

At a recent strategy meeting where my colleagues and I share investment ideas and insights, I was asked for my views on equity markets. I told them that I thought equity markets overall would be subject to multiple pushes and pulls this year as anticipation of a stronger recovery in growth is tempered by concerns about the impact of higher interest rates. Nevertheless, our team has identified five equity investment themes which we believe will be effective over the course of 2021.

Our first theme is the anticipated Post-COVID return to normal

The coronavirus pandemic created dramatic changes in consumer behavior, with clear winners and losers. Some of these trends are likely to endure, while others will likely reverse in 2021. Now, at the same time, fiscal stimulus and increased savings means that the consumer should exit the pandemic in great shape. However, if 2020 was the year of buying “stuff,” 2021 should be the year of buying experiences. So that would argue in favor of equities related to travel and leisure, as opposed to those related to consumer goods.

Our second theme is a capital expenditure (capex) recovery

The rise in commodity prices that we have seen in recent months has yet to be met with a supply response, and producers are unlikely to respond until they are convinced that the price recovery is more sustainable. At the same time, the pandemic had a dramatic impact on supply. Imagine how many oil wells were shut in last year when we were staring at negative $30 per barrel oil. So, as the pandemic fades and commodity producers become more confident in the sustainability of the recovery, they will bring back production and re-start stalled projects. We think the best way to invest in this theme is to focus on the companies that provide the services and equipment necessary to make that happen.

Our third theme is lagging growth stocks that have been left behind in the stock market rally

These are what we call high-quality GARP stocks—GARP stands for growth at a reasonable price—and these have been notable underperformers since the COVID bottom. Now, while your momentum technology stocks have been huge winners coming out of COVID, we’ve seen here in the month of February that their performance is vulnerable in a rising interest rate environment. More recently, we have also seen lower quality stocks—many of which are in industries that are in secular decline—that they have been rising now as well, but that’s been mostly due to covering of short positions. That trend is probably unsustainable—eventually those types of companies have to report earnings, and, if they disappoint, their relative underperformance will likely resume. Meanwhile, some high-quality above-average potential growth compounders, companies that have been durable over time but aren’t flashy, have kind of fallen through the cracks. So one area of the market where we are looking for those types of stocks is the business services sector. So look at business services for ideas that fit that description.

Our fourth theme is UK domestic equities

UK equities have been out of favor for quite a while now, and with good reason. The Brexit overhang combined with repeated COVID shutdowns damaged the economy and decreased confidence. Now, fast forward to today and the UK has one of the highest vaccination rates in the world. The government recently announced a plan that would end nearly all COVID-related restrictions by June. So that makes the UK market a good place to look for opportunities, but we would believe that investors would want to focus on domestic small caps that should directly benefit from the re-opening, less so than the big international companies.

Finally, our last theme is real estate equities

Real estate equities have been doubly out of favor. First, they were hit by COVID. While residential real estate held up well, many areas of commercial real estate were heavily impacted by the pandemic. Then, as other areas of the market started to recover from COVID, real estate equities were hit again, but this time by higher interest rates. But our analysis shows that historically when interest rates are rising because of strong economic growth, it’s a net positive for real estate. Eventually, that headwind of higher interest rates should give way to the tailwind of rising rents. So, we’re looking at real estate as a sector that has lagged the market but could recover some significant relative performance over the course of 2021.