Market Factors: Revenge of the old economy stocks?

This edition of Market Factors starts with the possibility of a major shift in global markets and then moves to bloated government debt and deficits. The diversion covers an important court case about social media and mental illness and we’ll have quick hits as usual.

Market trends

My trade idea is working, for now

In the January 19^th edition of this newsletter I suggested that rising skepticism about the AI trade implied that the equal weighted S&P 500 index might outperform the conventional market cap weighted benchmark while reducing volatility at the same time. This is now happening and we need to think through how long it will last.

The lazy Americans weren’t working on Jan. 19 so our performance data starts on the 20^th. Since that time the regular S&P 500 as tracked by the Vanguard S&P 500 Index ETF (VFV-T) is almost flat at 0.1 per cent higher as of Wednesday’s pre-market. The Invesco S&P 500 Equal Weight index ETF (EQL-T) is up 1.9 per cent for the same time frame. The U.S. traded Roundhill Magnificent Seven ETF is down 1.1 per cent when converted to Canadian dollars.

This could be a temporary blip and the stocks attached to data centre construction might regain market leadership. On the other hand, if we annualize the returns from the 20^th, it implies a 29.0 per cent return for the equal weighted ETF and a 1.9 per cent gain for the market cap-weighed index. A 27 percentage point spread is, to say the least, relevant to portfolio returns.

Now, these numbers should be taken with a big boulder of salt. They annualize a temporary move of less than a month which is not a big data set. It is mostly a sign of a trend that needs to be followed closely.

The top 10 performing U.S. stocks since Jan. 20 are a mixed bag of old and new economy. The top two returns are for Corning Inc. and Teradyne Inc. at 36 and 34 per cent, respectively. A non-tech company called Davita Healthcare Partners Inc. – it provides dialysis treatments - is next, followed by Sandisk Corp. and Charter Communications Inc.

Things take a distinct turn to non-technology after that. The next top performers are Royal Caribbean Cruises Ltd., Southwest Airlines Co., biotech company Viatris Inc., Dow Inc. and boring telecom provider Verizon Communications Inc.

There is no shortage of research reports recommending some bottom fishing in technology stocks this week – I mentioned Citi’s version in my research roundup on Tuesday. But what if old school industrial stocks like Dow assume performance leadership for the next few years? Technology stocks may be re-rated (pushed to lower valuation levels) because earnings growth is cheaper in manufacturing sectors. (Investors can pay lower PE ratios for stocks with profit growth similar to expensive tech stocks).

These are very early days if in fact there is a sector rotation underway in U.S. and global markets. The ongoing earnings reporting season is still seeing strong profit growth for tech, including the hyperscalers driving the data centre investment. Earnings guidance for health care, however, has been strong as well. Profit growth for industrials is a healthy 12.1 per cent year over year.

The relative returns of the equal weight S&P 500 and the market cap-weighted benchmark will continue to be my main barometer for this trend. Any sector trends in earnings guidance will also be important.

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Economics

U.S. government debt worse than it appears

There’s been a lot of handwringing about U.S. debt and deficit levels but the debt-to-GDP ratio, at roughly 120 per cent of GDP, pales in comparison to Japan’s 250 per cent. In a flippant mood, when asked about U.S. debt concerns, I have responded with “talk to me when we get over 200 per cent like Japan.”

Things are not as simple as they seem, according to a recent article by Toby Nangle at FT Alphaville (free with registration). The Japanese government holds assets that offset the debt, including a gigantic equity portfolio and massive profits on Bank of Japan foreign exchange interventions. Once these are taken into account, the government debt to GDP is almost exactly the same as the U.S.

The domestic federal debt-to-GDP ratio looks healthy at 65 per cent but again this doesn’t tell the full story. The feds have downloaded health care costs on to provincial balance sheets, which they loosely guarantee. On the whole, however, Canada’s debt position is healthier than the U.S. and Japan.

Knowing that the public financial health of Japan and the U.S. is equally precarious has changed my perspective a bit. Default is still out of the question, I think, but I am less sanguine about U.S. debt in light of another three years of political instability. Any situation where major nations decide to boycott U.S. bond purchases would really get my attention.

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Diversions

Social media on trial

Instagram is on trial in Los Angeles this week, charged with business practices that harm mental health. The suit initially included TikTok, Snap and YouTube but they paid their way out of it (out of court settlements). Atlantic writer Kaitlyn Tiffany posits that Instagram hung in because they knew they’d have to defend themselves in court eventually and now is as good a time as any.

Ms. Tiffany points out that the case is an important bellwether. There are similar legal accusations being made across the United States and there is a similar suit hitting federal court this summer. The stakes are therefore enormous.

The specific allegations charge Instagram with using features like endless scrolling and algorithms that make the product dangerously habit forming, and that no warnings were provided. They are further charged with borrowing tactics from slot machines and tobacco to ensure addiction.

The case will also be the first detailed public defence by lawyers employed by social media companies. The best quote in Ms. Tiffany’s terrific feature is from Corbin Barthold, an internet policy lawyer who complained that “having lawyers get up and give speech contests in front of a jury” is not a great way to determine a precedent for technology regulation and mental health.

I do believe that social media is detrimental to mental health even though I use it all the time. I do not think it’s a coincidence that the well-established trend of declining teen mental health beginning in 2011 coincides with the rise of social media.

There is also, however, the question of agency and how helpless people are to change habits they know to be harmful. I quit smoking five years ago and it was hard. I did it in large part because I knew it would be my fault if I got lung cancer or, even worse, the pancreatic cancer that killed my grandfather.

This is a really important case, not just for financial and investment reasons - the settlements for suits against social media companies would be vast if they lost - but also for sociological and psychological ones.

The essentials

Looking for our updates on market movers, analyst actions, stock technicals, insider trades and other daily, weekly and monthly insight? Click here to visit our Inside the Market page.

Globe Investor highlights

An indepth conversation with CIBC’s chief market technician Sid Mokhtari on his latest stock picks and market observations

A lesson on the dangers of stock concentration in a TFSA portfolio

Jamie McGeever observes that the global economy is at an odd ​juncture, one that points to an ugly few years for bond markets.

Quick hits

Fanduel announces earnings this Thursday and I’m among those who won’t be cheering any profit growth. As Scott Galloway has noted, online gambling has been targeted successfully at young males who are often blowing themselves up financially. The internet is really increasingly resembling Pottersville from It’s a Wonderful Life.

Scotiabank strategist Simon Fitzgerald-Carrier (you’re not allowed to work in Scotiabank strategy without a hyphen in your name) quantified China’s diversification away from U.S. debt issues. China’s holdings of Treasuries have dropped from US$1.3-trillion in 2013 to just over US$600-billion. No disaster has occurred so far but the Americans can’t look to China to soak up new issuance to fund their deficit.

See our full earnings and economic calendar here