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Market View

We think a closer look at how certain areas of the equity market performed during the recovery from the March lows may provide insights on the winners and losers of the post-shutdown era.

Read time: 3 minutes

The speed of the equity market reversal in late March and April has stunned many market watchers, who ask how markets can rally in the face of rapidly deteriorating economic and employment data, both in the United States and around the world. The simple answer is that markets have always been forward looking; they sold off before the negative data materialized, and bear markets historically have reached their lows and begun to rally well in advance of the end of a recession.

However, a closer examination of equity markets shows this rally is more nuanced than the early pricing of a simple “return to normal” scenario for the economy. Quite the contrary, performance across market capitalizations, industries, and other important factors–growth and value, for example–has been extremely varied (see illustration), suggesting that for some parts of the equity market, investors appear to be anticipating some lasting effects beyond temporary economic damage.

Which Companies May Survive …

Markets, looking beyond the immediate economic data, appear to be contending with two major questions.  First, which companies are likely to survive and which are not? Large cap companies often have more operational flexibility, more resources, and better connections with government entities and financing sources than smaller businesses. Smaller businesses are often more at risk for supply chain disruption as well, without the robust operational redundancies that larger companies typically enjoy. Given this competitive landscape, it makes sense that large caps have outperformed small caps. It is worth noting, however, that small caps have often led protracted market rebounds in the past. Though not yet the case, as uncertainty wanes, we would expect select, growth-oriented companies in the small cap arena to lead again.

Value companies are also more at risk during an economic slowdown than growth companies because they are more economically sensitive, typically have higher leverage, and are in industries with lower gross margins than their growth counterparts. Though investors often think of growth as “high beta,” the cyclicality and risk of value companies is actually a primary reason investors historically have demanded higher returns from this group. The pace of change and disruption has not been kind to value companies even before this pandemic, and we think the market is rightly judging that pace to be faster in the future, putting many value business models at risk of displacement.

… and Which May Thrive?

The second major question the market is considering is: Which industries and business models are expected to thrive in the new economic reality post-shutdown? Some industries are highly vulnerable to the effects of the measures to curb the virus, beyond the economic impact that affects all companies. Cruise lines, hotels, airlines, restaurants, and many other industries have high overhead, and require a critical volume of business to stay afloat – volume that may not materialize until it is too late.

Some industries will be resilient, especially those featuring innovative growth companies that thrive on change. Many of these can be found in the healthcare sector; of course, not only those that are directly developing treatments and helping manage through the effects of the coronavirus but also companies that address longer-term issues associated with an aging population and a constantly changing industry landscape. Information technology companies that enable remote working and productivity enhancement in a changing world also stand to benefit despite an overall decline in economic activity.

Summing Up

Of course, not every troubled value company will default, and not every winner of the COVID-19 era will continue to deliver on its potential. While successful managers can help to identify winners and losers during this period of change, we would suggest that traditional style boxes may be overly reductive and fail to differentiate between companies with past growth and those that are reaching an inflection point of their innovative potential. Similarly, “value” can include dividend-heavy, maturing businesses, highly regulated financials, or troubled energy companies, yet there are many other firms in this category with the resources and dynamism to dominate their industries as we emerge into a new and different environment.

The COVID-19 virus has unquestionably changed the world. We believe that flexible investment mandates and deep, industry-focused research capabilities will prove to be crucial in adapting to this new investment landscape.

 

MARKET VIEW PDF


  Market View

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The Lord Abbett Growth Leaders Fund Class A seeks to deliver long-term growth of capital by investing primarily in stocks of U.S. companies. Learn more.
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