Heavy sector rotation has defined the market landscape for the past several weeks. Banking, machinery, materials, chemicals, oil, and steel stocks have rallied strongly and reignited sentiment that just maybe this isn’t a one-off rally or bull trap that fades, as has been the case for old economy stocks in years past.
Because investors have been so well rewarded in a low-growth, low-rate, low-inflation economy for so long, the notion of this paradigm undergoing such a seismic shift in such a short period of time has caught much of the investing world flat-footed. For example, 2021 began with the 10-year T-Note yield at 0.90%, and now almost has doubled as of the recent high quote of 1.75% on March 18.
Big government spending got well-lubed when the Jan. 5 election runoff in Georgia secured the path to simple majority budget reconsolidation passage of the $1.9 trillion stimulus package now in play that soon may be followed by a massive, all-inclusive $3-4 trillion infrastructure bill that will involve a lot more than just infrastructure. The new plan is very fuzzy on details, but recent documents suggest it will include nearly $1 trillion in spending on the construction of roads, bridges, rail lines, ports, waterways, wastewater treatment, electric vehicle charging stations, and improvements to the electric grid and other parts of the power sector.
This is all good, decades overdue, and has widespread bipartisan support. So, what’s up with the other $2-3 trillion in the proposed “infrastructure” package?
This next-up package would include more Affordable Healthcare Act subsidies and more people-focused proposals, like free community college, universal pre-kindergarten, a national paid leave program, forgiveness of student loans, universal income, jobs training, climate change initiatives, and Green New Deal research. Progressives like to call this “human infrastructure” spending.
While the semantics of this newly-adopted and wider meaning of infrastructure might cause some confusion and spark debate, there is little misunderstanding about how it all is going to be paid for. While the $1.9 trillion is being paid for by debt, it is understood at this point in time that the next big push of Congressional spending will primarily be paid for by taxes that will probably affect more than only corporations and the wealthy.
The template is being prepared for widespread taxation that will accompany this historic peacetime spending spree that has the potential to radically alter inflationary expectations going forward. Higher taxes and higher minimum wage laws will be passed on by higher prices for goods and services — market forces that the government can’t control. This modern-day Great Society program being promoted is not America’s first rodeo with strong economic growth and rising inflation.
Deutsche Bank economists stated this past weekend “the last time free-spending, inflation-permissive regime shifts for policymakers coincided, such shifts touched off a sustained surge in inflation.” (source: Investor’s Business Daily, March 29, 2021) The DB economists are speaking of the 1965-1968 period when the rate of core inflation went from under 2% to nearly 5%.
The combined efforts of easy Fed monetary policy to stoke inflation and the fiscal firehose of Congressional spending has the Dow and S&P 500 trading at new all-time highs with the Nasdaq off about 8% as of last Friday’s close. Earnings season kicks off in earnest the week of April 15 and should be a barn burner where confidence in forward guidance has a bigger impact on sentiment than concerns about tax hikes.
The market is already digesting the eventuality of bigger spending and higher taxes. Until there is real evidence that inflation threatens to rise above 2.5%, the market should trend higher on robust sales and earnings projections.
Heading into last weekend, we saw the first signs of a shift back into tech by way of the semiconductor stocks surging higher in Friday’s session. It can be considered that semis and semi-equipment companies are the modern-day industrials. Chips are embedded in every industry at many levels. Just as a point of reference, the average electric vehicle has 3,500 semiconductors built-in.
Worldwide semiconductor market growth is expected to accelerate in 2021. The worldwide semiconductor market is expected to increase by 10.9% in 2021 to produce sales of $488 billion. The market is driven by sensors, 16.8%; followed by analog, 15.2%; and logic, 13.0%. Double-digit-percentage growth is expected for all geographical regions, except the Americas (source: World Semiconductor Trade Statistics, March 2021).
It is important that investors not get too caught up with the back-and-forth of the growth versus value debate. High-tech companies that are crucial suppliers to cyclical companies stand to really benefit hugely from the economic rebound, arguably more so than the companies they supply. This might be why, in a market where the Nasdaq is off 8%, shares of some leading chip and chip-equipment makers are surging to new highs.
What I’ve come to observe these past few months is that while the market has heaved, rallied, and witnessed intense sector rotation, the semiconductor sector has a broad application in all 11 sectors of the market. All major businesses in technology, health care, utilities, consumer staples, communications, materials, industrials, transportation, real estate, energy, and finance depend heavily on semiconductors being the guts of the platforms they operate on and the products and services they deliver.
The takeaway from this highlighting is that regardless of the ongoing growth versus value dialogue, the chip and chip equipment sectors can claim to be both. They perform well in deflationary environments when most of the economically sensitive industries are out of favor and they should perform just as well, and maybe even more so, as all the businesses they touch begin to flourish and gross domestic product (GDP) hits its stride at a 6%-plus growth rate.
There could well be more rotation out of high-valuation growth stocks that have strong top-line growth, but no earnings to speak of. But what we saw late last week was a very strong appetite from professional money to own the semiconductor stocks during end-of-the-quarter window dressing. That in itself is a buy signal for investors when the market provides opportunities to acquire these modern-day industrials on pullbacks.