Investing

Is The Stock Market At A Style Inflection Point?

The COVID bull market that began the first week of April 2020 continues to grind higher, with the S&P 500 and the NASDAQ Composite recently hitting all-time highs. This move has been led by the U.S. economy’s ongoing improvement from the depths of the pandemic and continued money supply growth, fueled by both the Fed’s securities purchases and the government’s fiscal stimulus. In addition, despite rising inflation, U.S. interest rates have remained historically low, enabling stocks to continue to carry high valuations. While the investment backdrop will eventually change, if the present conditions remain in place, the path of least resistance for the equity market appears higher.

Much of the gains so far in 2021 have been driven by value and cyclical stocks’ marked moves higher. Financials, industrials, consumer cyclicals, energy, and basic materials have all enjoyed a good year. Financials have been aided by a steepening yield curve, represented by the two-to-10 year Treasury yield spread (currently 121 basis points), which improves net interest margin on loans. Industrials have been supported by recovering global machinery and equipment demand as well as a potential large U.S. infrastructure bill. Consumer cyclicals were helped by the combination of an extremely strong U.S. housing and home-renovation market and sharply accelerating retail demand and stimulus. Energy has been boosted by oil and natural gas price increases, while a combination of supply shortages and increasing demand for aluminum, copper, and iron ore/steel has driven basic materials.

From just after the presidential election in the second week of November 2020, this cyclical performance was at the expense of more classic growth stocks. However, the S&P 500 Growth Index, represented by the ETF SPYG, has recently begun outperforming the S&P 500 Value Index, represented by the ETF SPYV. I have not yet seen enough confirmation in this new trend to suggest a return to long-term growth stock outperformance, but the next few weeks should be telling.

The recent growth spurt has been helped by mega-cap technology stocks like Microsoft (MSFT), Google (GOOGL), Adobe (ADBE), Nvidia (NVDA), and Facebook (FB), a few hyper growth names now back at highs (ex: SHOP, CRWD, DOCU, NET), as well as sharp bounces from lows in very oversold areas like recent IPOs, small/mid software and internet, and alternative energy. Actual S&P 500 breadth figures have not been impressive, with 54% of the index currently trading below their 50-Day Moving Average (DMA). Another measure, the percent of NYSE stocks below their 100-DMA, is also declining, albeit from an extreme level in February.

While mega-cap performance has masked what is essentially a consolidation in the broader market, I am optimistic that this shift back to growth will take the market higher. One reason for this optimism is that growth names were teetering on the verge of a larger breakdown in May. This counter-rotation back in their favor gives the market some legs while cyclical areas digest their prior uptrend. As this has happened, O’Neil’s proprietary measure of U.S. stock breakouts has dropped off, mirroring the lower breadth indicators.

The best scenario for the equity market going forward would be a period of consolidation in financials, industrials, cyclicals, energy, and basic materials, as opposed to an outright correction. I’ll continue to watch these names to see if their current pullbacks are the beginning of healthy base formation or something more troublesome. Deeper corrections would suggest that investors are likely to be disappointed in U.S. economic growth over the next 12 months.

Even the most powerful bull market often features leadership rotation, and growth’s resurgence could be setting the stage for broader gains in the second half of the year. In the meantime, let’s take a look at three names I like from a fundamental standpoint that are at timely entry points, emerging out of consolidation.

CrowdStrike (CRWD) is a cloud-based endpoint security provider through its flagship Falcon platform, run on laptops, desktops, and servers, which protects workloads across on-premise, cloud, and virtual environments. The global opportunity serving end-markets related to corporate and individual security is expected to grow from $32B in 2021 to $39B by 2023. Subscription revenue makes up around 90% of the company’s revenue. In the most recent quarter, the number of subscriptions grew 85% to more than 8,400, including half of Fortune 100 companies. CrowdStrike’s revenues have grown an average of more than 80% y/y over the past eight quarters and, while some deceleration is to be expected, the company should continue growing its top line 30‒50% per quarter for the next several years. The stock has emerged from a four-month consolidation back into all-time highs over the past two weeks, providing another timely entry.

Intuitive Surgical (ISRG) is a $107B market-cap leader in robotic-assisted surgery systems (with its da Vinci platform) with a 70% global market share. The market is worth about $4B currently and is growing 15%+ annually, taking share from traditional surgery, which is growing around 5%. Robotic surgery still has a very low share of the overall market, just 2% globally and 10% in the U.S. The company’s recurring revenue is very high, 76%, insuring strong revenue stability. Driven by lockdowns, sales dropped in 2020 but have quickly returned to growth, with Q1 2021 revenues up 18% y/y. Full-year 2021 and 2022 revenues are expected to grow 22% and 15%, respectively, and profits are expected to grow even faster as the company returns to 40%+ P/T margins. The stock broke out of an eight-week flat base and into all-time highs this week. While it has been a strong for the past year, it is not too late to own given its market dominance and consistent growth.

Footwear and apparel giant Nike (NKE), with a market cap of $240B, has sales spread across North America (~40%), EMEA (~25%), China (~20%), and other Asia/Latin America (15%). It generates two-thirds of revenue from wholesale channels and one-third from direct-to-consumer. On June 24 it reported stellar Q4 FY21 earnings results. Revenue grew 96% y/y, driven by weak prior-year comparisons, but also grew nearly 20% q/q to an all-time high and beat consensus by 12%. North America and EMEA revenues grew by triple digits. The wholesale channel led the way this quarter, however, going forward, the company plans to push DTC sales to 60% of revenues by FY25 from 37% currently. This higher-margin segment should drive operating margins to the high teens by FY25 from around 16% currently. For FY22, Nike expects 125‒150 basis points of margin expansion, implying EPS well above the current consensus of 10% y/y growth. The stock exploded out of a six-month consolidation into all-time highs following the results, and I believe it can continue much higher from here given its business momentum and that it has lagged so sharply year-to-date.

Kenley Scott, Director, Global Sector Strategist at William O’Neil + Company, an affiliate of O’Neil Global Advisors, made significant contributions to the data compilation, analysis, and writing for this article.

DISCLOSURE:

No part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed herein. O’Neil Global Advisors, its affiliates, and/or their respective officers, directors, or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein.

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