A Risky Stock Rotation?

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The recent interest rate scare has spurred a market rotation from growth stocks into value. Almost any company that had good performance heading into March saw weakness regardless of the fundamentals. In many pockets, stocks were down 30% in contrast to markets that were flat or even up. The table below displays returns, which hides a lot of the volatility underlying the markets.

The market returns but volatility within the markets highlight that there appears to be an equity market rotation as opposed to assets going from equity to fixed income or cash. This is where you can have certain sectors decline, but other areas offset it and potentially lift the broad markets.

If we are indeed seeing a rotation, what exactly performed well and what lagged? We looked at the performance of the underlying stocks in the TSX composite and S&P 500 and separated out companies that were above the market performance over the last month, and companies that were below the market performance. This essentially creates a ‘winners’ and ‘losers’ bucket. Then we wanted to see the general composition of companies that were in these two buckets. The below table highlights what we found.

The results seem to align with the general commentary investors are hearing that a lot of the companies that have fared well in the last month or two have tended to be lower-quality value names. In the S&P 500, we see that the general trend of ‘winners’ looks to be more value-oriented. Of interest though, the ‘winner’ basket also appears to have lower-quality balance sheets (lower current ratio and higher debt/equity) as well as a lower average return on equity (ROE).

The TSX actually has a bit of a different dynamic, with what looks like higher-valued stocks doing well. We think this is more of an ‘anomaly’ in that a lot of this probably relates to energy companies that show high earnings valuations but would more than likely look cheap on other metrics such as price/book. Regardless, the trend around fundamentals remains the same with lower quality balance sheets appearing to outperform. Similar to the P/E ratio, ROE is a bit skewed due to commodity companies being a larger part of the ‘loser’ bucket.

As always, diversification and time frame help protect from these types of risks. If an investor did not own lower-quality value in the last month, they probably felt the pain a bit more than the markets show, but it is a single month in a long-term endeavor, and being properly diversified allows an investor to ‘fight another day’.

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