Equity markets bounced back Wednesday after a three-day rout that saw the Nasdaq enter its first official correction – a decline of more than 10 per cent from recent highs – since the recovery that started in March.
The market was certainly overdue for this pullback. The Nasdaq had soared to 30 per cent above its 200-day trendline a week ago and the forward price-to-earnings hit a silly 18-year high of 33 times. In fact, the average trailing multiple on the top 10 U.S. tech companies was 75 times heading into this latest bout of market turbulence.
I did some historical fact-finding because I wouldn’t be at all surprised that most of the bounce off the March lows gets unwound as these visions of a V-shaped recovery fade away. With that in mind, we have to be cognizant of the fact that, if Wednesday’s rally is short-lived and this correction in the U.S. stock market that started last week ends up being 30 per cent or bigger, then it will be time to step in.
That is right.
We went back to all the prior periods since the 1987 meltdown – the 2001-02 slide, the 2008-09 plunge and the huge pullback we endured in February-March of this year – and had you put money into the S&P 500 at the very point that the market sunk 30 per cent, you would have more than tripled your money. That’s what comes from investing at such a low base. (Incidentally, you would have done so even if the market then overshot that 30 per cent to the downside, as it did in 2001-02 and 2008-09.)
We get asked what the next secular themes are going to be. It was mass consumerism in the 1980s. The internet in the 1990s. China in the 2000s. Banking and mortgage finance in the first decade of this century and anything related to technology these past 10 years – cloud computing, artificial intelligence, 5G and the like.
What’s the next “big thing”? Coming out of this pandemic, I can’t help but believe it will be in biotech, pharma and digital – and not in the large caps, but in the smaller companies.
This is a very ignored and under-owned part of the landscape, and companies have seen their share prices correct hard from their 52-week highs. Here’s a sampling from the S&P SmallCap 600 Index: The health care technology space, as of Tuesday’s close, is down 14 per cent from its highs. Small cap pharma has corrected 11 per cent from its highs and medical equipment providers are down just over 30 per cent. Internet retailing is off 26 per cent and internet services is down 20 per cent. Defence/aerospace technology is down 33 per cent and environmental services in the small cap space is 31 per cent away from the former highs.
So when you hear people say “there’s just no value in this market” when they discuss equities, my advice is to tell them to look beyond the megacap blue chips that have become over-owned and overvalued household names, and where the valuations point to little, or even negative returns, in the years ahead.
Search for the gems in the health care space, particularly within the small and mid-cap sectors where the return potential is vastly superior.
Life is going to change. It already has changed, and it is tough to believe that small, entrepreneurial and under-owned small-cap health care stocks won’t be big winners in your portfolio for the coming decade.
David Rosenberg is founder of Rosenberg Research, and author of the daily economic report, Breakfast with Dave.
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David Rosenberg