Now that the S&P 500 has climbed back to less than 200 points below its February highs, it seems like the stock market is going strong on hopes of economic recovery after U.S. gross domestic product declined by 4.8% in the first quarter.
The Buffett Indicator, which measures total market valuation by comparing the GDP of a country to the total market cap of its businesses, shows that the U.S. stock market is significantly overvalued as of June 4, indicating that the market is positioned for an average annualized return of -1.8% per year.
However, the price recovery has not applied equally to all sectors and stocks. A lot of the money has gone to popular tech stocks, with the Nasdaq Composite Index rising to only 1.4% below its all-time high at market close on June 3.
Despite the high valuation of the overall market, there could still be attractive opportunities present in the form of stocks in out-of-favor industries. Some recently out-of-favor industries, such as transportation, are already seeing their stock prices rise again, while others remain out of favor or are likely to decline further before making a comeback.
Industries coming back into favor
Retail, restaurants, transportation, travel and leisure and oil and gas were among the most out-of-favor industries in March and April. However, according to GuruFocus’s list of 52-week lows, less than 5% of the stocks in these industries are currently trading within 10% of their 52-week lows.
With the pandemic slowing or stopping revenue streams to these businesses, many struggled to make ends meet. In general (though there were exceptions), losses in these sectors seemed to correlate with debt; the more debt a company had, the more its shares were sold off.
For example, the four major U.S. airlines, Delta (DAL, Financial), American (AAL, Financial), United (UAL, Financial) and Southwest (LUV, Financial), saw their share prices drop 51%, 57%, 64% and 34%, respectively, before rebounding to more than 10% above their 52-week lows by June.
The stock prices of cruise lines fared even worse, since no one wants to be trapped aboard a “petri dish” during a pandemic. The cruise lines are also famous for their weak balance sheets. Norwegian Cruise Line (NCLH, Financial) warned investors of a possible bankruptcy in May before taking on an additional $2 billion in debt. Like the airlines, most major cruise lines are now trading at least 10% above their 52-week lows.
With oil and gas, high-risk smaller players such as Occidental Petroleum (OXY, Financial) lost as much as 80% of their market value, while bigger names like Exxon Mobil (XOM, Financial) saw declines of less than 50%. Several gurus counting on a rebound in oil prices picked up shares of embattled producers during the first quarter of 2020. For example, 12 gurus bought shares of Exxon Mobil, six bought shares of Occidental and 11 bought shares of Apache (APA).
The recoveries of popular retail and restaurant stocks have been a bit faster, perhaps partially because they are returning to operations more quickly than travel-related stocks. Starbucks (SBUX), Restaurant Brands International (QSR), Ulta Beauty (ULTA) and Ross Stores (ROST) have seen their stock prices rise 75%, 36%, 68% and 57%, respectively, from March lows.
Industries that remain out of favor
Despite optimistic investor sentiment for the stocks that were more obviously out of favor during Covid-19 lockdowns, there are some industries where more stocks are still trading near their lows. Some of these types of businesses, such as diversified financial services and conglomerates, face significant headwinds, while others, such as real estate, tend to follow the cycle of the economy to a much greater degree than the stock market.
According to GuruFocus data, 68% of companies in the diversified financial services industry and 16% of the companies in the conglomerates industry are trading within 10% of their 52-week lows.
So-called “diversified financial services” companies mostly consist of blank check companies, which are development-stage enterprises that either do not have a business plan or plan to grow into conglomerates through mergers, acquisitions or other corporate actions. They are extremely risky and speculative in nature and often fall under the category of “penny stocks.”
Conglomerates, which grow through acquisitions, are often the end-goal of blank check companies, though most conglomerates begin with one or more primary business and begin expanding into other sectors. Icahn Enterprises (IEP, Financial), which has seen its stock decline 19% year to date, is one example of a conglomerate.
Another famous conglomerate is Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial), though the company is technically defined as an insurance operation because the largest portion of its income is garnered from the insurance businesses.
A higher percentage of real estate stocks are also still trading within 10% of their 52-week lows. According to GuruFocus data, 16% of stocks in the industry fall into this category. As shown in the chart below, the net income of major real estate companies fell during the financial crisis as fewer people had the financial means or inclination to purchase a new home. Real estate is notoriously difficult for a company to gain a competitive advantage in, as consumers have many choices and often go with the best deal or a specific location or amenity. Thus, business tends to follow what people are able and willing to spend overall.
Conclusion
The U.S. stock market has recovered significantly from its lows in March. As always, predicting the stock market is impossible because the stock market is not same as the economy, but there are still areas of the market that could offer more value than others.
Industries that have been more obviously hit by Covid-19 lockdowns, such as transportation, are already beginning to see recovery in their stock prices. On the other hand, industries that depend on larger purchases, such as real estate, may find themselves more affected by the country’s drop in GDP.
Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.
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