The new bull market of Wall Street that started after exit from the coronavirus-led shortest bear market in April 2020 is showing no signs of decline. The U.S. stock market ended the first quarter of 2021 on a high note.
The three major stock indexes — the Dow, the S&P 500 and the Nasdaq Composite — rallied 7.8%, 5.8% and 2.8%, respectively. Moreover, the small-cap specific Russell 2000 jumped 12.4% and the mid-cap centric S&P 400 climbed 13.1%. All these reflect a broad-based rally in first-quarter 2021.
Meanwhile, three important developments took place in the last quarter. These developments may determine the course of stock investing in the rest of this year. Let's discuss them briefly.
Cyclical Stocks Outperform Growth Stocks
The first major change in investment pattern in the first quarter was that investors' preferences shifted to cyclical sectors like oil and energy (up 29.5% year to date), industrials (11.2%), materials (8.9%), financials (16.4%) and consumer discretionary (4.5%) from growth-oriented technology (2.2%). Notably, the technology sector was the primary driver of the new bull market in pandemic-ridden 2020.
Meanwhile, approval of three COVID-19 vaccines by the FDA and the ramp up of nationwide vaccination process by the Biden administration raised market participants' hopes of a faster-than-expected reopening of the U.S. economy.
Several recently released economic data also indicated strong recovery of the U.S. economy. These developments compelled investors to opt for cheaply-priced cyclical stocks over technology stocks, which were already overvalued.
It remains to be seen how cyclical stocks, supported by reopening of the domestic and global economy, will maintain leads over technology stocks that have an inherent growth path.
Soaring Bond Yields and Inflationary Expectations
The U.S. economy is witnessing strong recovery since the beginning of 2021 buoyed by $900 billion of second-round fiscal stimulus and a fresh round of a massive $1.9 trillion relief package approved by the Biden administration. Furthermore, an estimated $1.5 - $1.8 trillion savings by Americans also supported strong pent-up demand.
Strong economic recovery resulted in stock market rally, which compelled investors to shift from safe-haven government bonds to risky equities. Consequently, the yield of the benchmark 10-Year U.S. Treasury Note soared to a 14-month high at 1.776% on Mar 30. Notably, this yield was around 0.9% at the end of 2020.
Higher risk-free return means higher discount rate that will reduce the net present value of stock investing. Some economists and financial experts expect the yield of 10-year U.S. Treasury Note to hit 2% in the second quarter.
Moreover, market participants are concerned about higher inflation in the near term due to strong pent-up demand that may force the Fed to raise benchmark interest rate. Although Fed Chair Jerome Powell said that such inflation will be transitory in nature, investors are skeptical that a spiraling inflation may force the Fed to change its whole course of policy prescriptions. Higher inflation will also reduce net gain from stock investing.
New Infrastructure Plan and Tax Hike Proposal
On Mar 31, President Joe Biden unveiled his $2.3 trillion infrastructure development plan that includes transport, drinking-water, broadband, manufacturing and construction infrastructure developments. Some economists believe that final expenditure may reach around $4 trillion as additional parts are announced.
However, to finance the massive cost of infrastructure project, the Biden administration has proposed to raise corporate tax rate from 21% to 28%. We note that the previous Trump administration reduced corporate tax rate from 35% to 21%.
According to several published reports, the U.S. economy is likely to grow by 6.5-7% in 2021, its highest rate in 33 years. Total corporate earnings of the S&P 500 companies are expected to jump 24.4% on 8.4% higher revenues in 2021, after plunging 13% on 1.8% lower revenues in 2020. It remains to be seen how Biden's new infrastructure plan and corporate tax hike proposal will impact U.S. GDP and corporate profits.
Our Top Picks
We have narrowed down our search to five U.S. corporate bigwigs (market capital > 50 billion) as these companies have a well-established business model and powerful brand value. These stocks have strong upside potential for 2021 and witnessed robust earnings estimate revisions in the past 30 to 80 days.
Moreover, all these stocks have strong long-term (3-5) growth prospects and have provided more than 15% returns year to date. Finally, each of our picks carries either a Zacks Rank #1 (Strong Buy) or 2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
The chart below shows the price performance of our five picks year to date.
Exxon Mobil Corp. XOM has an expected earnings growth rate of more than 100% for the current year. The company has a long-term growth rate of 9.5%. The Zacks Consensus Estimate for the current year has improved 36.6% over the past 30 days. The stock price of this Zacks Rank #1 company has jumped 35.4% year to date.
Deere & Co. DE has an expected earnings growth rate of 82.5% for the current year (ending October 2021). The company has a long-term growth rate of 19.2%. The Zacks Consensus Estimate for the current year has improved 20.1% over the past 60 days. The stock price of this Zacks Rank #2 company has soared 39.1% year to date.
The Goldman Sachs Group Inc. GS has an expected earnings growth rate of 22% for the current year. The company has a long-term growth rate of 20%. The Zacks Consensus Estimate for the current year has improved 1.6% over the past 60 days. The stock price of this Zacks Rank #2 company has advanced 24% year to date.
ConocoPhillips COP has an expected earnings growth rate of more than 100% for the current year. The company has a long-term growth rate of 5%. The Zacks Consensus Estimate for the current year has improved 22.8% over the past 30 days. The stock price of this Zacks Rank #2 company has climbed 32.5% year to date.
Micron Technology Inc. MU has an expected earnings growth rate of 59.7% for the current year (ending August 2021). The company has a long-term growth rate of 9.2%. The Zacks Consensus Estimate for the current year has improved 17.1% over the past 30 days. The stock price of this Zacks Rank #2 company has surged 17.3% year to date.
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