The first several months of 2021 have seen strong stock market performance, especially among more economically sensitive sectors, as the economy begins to reopen. When the economy comes out of a recession, we typically see a shift toward higher-risk assets, such as small-company stocks and highly leveraged or unprofitable companies. We certainly saw this happen in the first quarter.
Earlier this year, we saw the boom in so-called ‘meme’ stocks such as Gamestop and in Special Purpose Acquisition Companies or SPACs (which are shell companies that raise funds to acquire another company in the future). The beginning of the year was very much “risk on.” Conversely, many of last year’s winners, which often included quality growth companies, underperformed.
As the economy recovers and moves into what we would call the “expansion” phase of slower and steadier growth, we would expect to see a shift from the very high-risk asset classes to companies with more attractive earnings. We would still favor economically sensitive stocks but look for the higher quality companies with strong earnings within those sectors. We suspect that the recent outperformance of small-company stocks may come to an end but that value stocks may outperform growth stocks for a while longer.
As the economic expansion continues and the economy at some point begins to slow, we would likely then move more into large growth companies (such as the large technology stocks). Companies that can generate growth even in a slowing economy tend to do well later in the economic cycle. But hopefully, the current economic expansion continues for some time. And as the expansion continues, we will favor companies with attractive businesses and strong earnings potential.
Author David Royal is chief investment officer and asset management executive at Thrivent.