A Disturbance in the Force

The market news this week centered around a number of huge initial public offerings. The two biggest were the IPO’s of Door Dash and Airbnb. In what has become more and more common, IPO’s of companies with a large retail user base have exploded higher out of the gates. On Wednesday, Door Dash’s stock price more than doubled its initial public offering price. Thursday witnessed Airbnb replicate Door Dash’s strong performance. After these impressive starts, Door Dash is worth more than 1/3 of McDonald’s and Airbnb is worth more than Marriott, Hilton and Hyatt Hotels combined.

While these two stocks were definitely the headliners of the week, they were not the only stocks to see strong performances. Thirty stocks went public this week and the average return, at current writing, of these 30 stocks has been over 32%. It remains to be seen whether or not this is a sign of “Irrational Exuberance,” but it definitely is a sign of exuberance. Over the last couple of months it seems that there has been a shift for the headline momentum stocks grouped under the moniker FAANG + Microsoft (Facebook, Amazon, Apple, Netflix and Google) towards newer and shinier “disruptors” and these new IPO’s are a part of that trend.

But it isn’t just newer tech companies stealing large techs thunder. Since September 30^th, the S&P 500 has gained over 9%. During this same time, FAANG + Microsoft have averaged a return of only 4.82%, with Google the only one to outperform the broader market. The performance of these stocks has been dwarfed, during this period, by the performance of stocks harder hit by the pandemic. The likes of American Airlines, Spirit Air, Royal Caribbean, JP Morgan, Goldman Sachs, Bank America, and Exxon Mobil since September 30^th have compiled an average return of over 30%. This represents an important shift in market sentiment. The “stay at home” trade seems to be dying on the vine. Zoom and Wayfair, two huge winners during the pandemic, are each down over 17% in the last two months.

How long this rotational trend continues remains to be seen. A big indicator of this rotational play has been the outperformance of the Russell 2000 small cap index vs the Nasdaq 100 index. In a nutshell this trade has encapsulated the year’s pandemic market. From the March low until September 2^nd the Nasdaq 100 outperformed the Russell 2000 by over 25 percentage points. Since 9/2, the Russell has gained back over 20 percentage points. The question of whether this trade stalls out or continues on is actually quite an interesting conundrum and one that may solely depend upon whether fiscal policy takes the lead over the next few years or whether we continue to depend upon monetary policy to solve all economic ills.

The tech heavy Nasdaq has been a unique beneficiary of Federal Reserve policy. While this benefit has been much more apparent over the last decade, with short term interest rates stuck near zero for almost the entire time, this unintentional benefit to tech companies actually goes back well before 2000. The race to zero in interest rate land has had the benefit of providing “free” money to young and old tech companies alike. As interest rates collapse, the focus has shifted from earnings growth to revenue growth. This shift has allowed the likes of Amazon to spend nearly its first 20 years without earning a dime profit. This gift from the Fed and investors has given Amazon the opportunity to spend money on development rather than focusing on shorter term results. A luxury not afforded more established competitors like Walmart.

However, if we do witness a shift away from monetary policy towards fiscal spending it is likely that we will begin to see spending pressure start to push up prices. Pricing pressure will cause interest rates to rise, thus potentially forcing a shift away from high p/e multiple stocks, with fund flows pouring into lower multiple value stocks. There will be a shift from revenue growth back towards earnings growth. Which would ultimately turn the Long Russell 2000/short Nasdaq 100 trade from a shorter term phenomenon into a long term secular trend.

The impact this has on “momentum” equity positioning really depends upon how one defines momentum. Momentum should be understood as allocating to more recent winners. Momentum does not entail a reliance upon growth stocks. As trends shift, the momentum trade shifts accordingly. It is what makes momentum investing enticing. It doesn’t attempt to project the next cycle it only attempts to ride it once it materializes.

In a little more than one month we will have a new leader in the White House. There seems to be a growing push for more federal spending. To this end, it seems only a matter of time before this shift occurs. However, as we know, Washington typically moves slow. Neither party likes to give the other party a “win.” Which, should the Republican’s maintain control of the Senate, may create a slower migration towards fiscal policy as an economic driver. But it does seem, over the next 15 years or so fiscal policy will re-emerge from its 50 year slumber and once again become a force to reckon with for financial markets.

Thanks for reading,

Zach and Dave  

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