by Bryan Perry

March 30, 2021

Heavy sector rotation has defined the market landscape for the past several weeks: Banking, machinery, materials, chemicals, oil and steel stocks have rallied strongly and reignited sentiment that just maybe this isn’t a one-off rally or bull trap that fades, as has been the case for “old economy” stocks in years past.

The year 2021 began with the 10-year Treasury Note yield at 0.90%. That rate has now almost doubled to 1.75% as of the recent high quote of 1.75% on March 18. Because investors have been so well rewarded in a low-growth, low-rate, low-inflation economy for so long, the notion of this paradigm undergoing such a seismic shift in such a short period of time has caught much of the investing world flat-footed.

Big government spending got well-lubed after the January 5 election runoff in Georgia secured the path to a simple majority passage of the $1.9 trillion stimulus package, now soon to be followed by a massive all-inclusive $3-$4 trillion infrastructure bill that will involve a lot more than just infrastructure.

The next big spending plan is very fuzzy on the details, but recent documents suggest that it will include nearly $1 trillion in much-overdue spending on the construction of roads, bridges, rail lines, ports, waterways, wastewater treatment, electric vehicle charging stations, and improvements to the electric grid and other parts of the power sector. This is all good and decades overdue, with widespread bipartisan support, but what’s up with that extra $2-$3 trillion in the proposed “infrastructure” package?

This “infrastructure” mega-spending package would likely include more Affordable Healthcare Act subsidies and more people-focused proposals like free community college, universal pre-kindergarten and a national paid leave program, forgiveness of student loans, universal income, jobs training, climate change initiatives and Green New Deal research. Progressives like to call this “human infrastructure” spending.

While the semantics of this newly adopted and wider meaning of infrastructure might cause some confusion and spark debate, there is little misunderstanding about how it will be paid for. While the $1.9 trillion is being paid for by debt, the next big push of Congressional spending will likely be paid for by an increase in taxes, which will probably be raised on more than just the big corporations and the wealthy.

This historic peacetime spending spree has the potential to radically alter inflation expectations going forward. Higher taxes and higher minimum wage laws will be passed on, via higher prices for goods and services – market forces that the government can’t control. We’ve been here before. These modern-day Great Society programs will not be America’s first rodeo combining strong growth with rising inflation.

Recalling 1965-1968, when core inflation rates soared from under 2% to nearly 5%, Deutsche-Bank economists said, “The last time free-spending, inflation-permissive regime shifts for policy makers coincided, such shifts touched off a sustained surge in inflation” (source: Investor’s Business Daily,  March 29, 2021).

The market is already digesting the eventuality of bigger spending and higher taxes, and until there is real evidence that inflation threatens to rise above 2.5%, the market should trend higher on robust sales and earnings projections. The combined efforts of easy Fed monetary policy to stoke inflation and the fiscal firehose of Congressional spending has the Dow and S&P 500 trading at new all-time highs.

Earnings season kicks off in earnest shortly, in the week of April 15, and it should be a barnburner, where confidence in forward guidance has a bigger impact on sentiment than concerns of tax hikes.

Five Year, Five-Year Forward Inflation Breakeven Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Nasdaq has been the laggard recently, but heading into last weekend, we saw the first signs of a shift back into tech by way of the semiconductor stocks surging higher in Friday’s session. Semis and semi-equipment companies can be considered modern-day industrials. Chips are embedded in every industry at many levels. Just as a point of reference, the average electric vehicle has 3,500 semiconductors built in.

Worldwide semiconductor market growth is expected to accelerate in 2021. The global semiconductor market is expected to increase 10.9% in 2021, which corresponds to sales of US$ 488 billion. The market is driven by Sensors (+16.8%), followed by Analog (+15.2%) and Logic (+13.0%). Double-digit growth is expected for all regions except the Americas (World Semiconductor Trade Statistics – March 2021).

It’s important that investors not get too caught up with the back-and-forth of the growth vs. value debate. High-tech companies that are crucial suppliers to cyclical companies stand to benefit hugely from the economic rebound, arguably more so than the companies they supply. This might be why Nasdaq is off 8% in a market where the shares of some leading chip and chip-equipment makers are at new highs.

I’ve come to observe these past few months that when the market has heaved and rallied and witnessed intense sector rotation, the semiconductor sector has a broad application in all sectors of the S&P 500. All  major sectors – technology, healthcare, utilities, consumer staples, communications services, materials, industrials, transportation, real estate, energy and finance – depend heavily on semiconductors being the guts of the platforms they operate on, and the products and services they deliver.

Semiconductor Vaneck Exchange Traded Fund Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The takeaway is that regardless of the ongoing growth versus value debate, the chip and chip equipment sector can claim to be both value and growth. They perform well in deflationary environments, when most of the economically sensitive industries are out of favor, and they should perform just as well and maybe even more so as all the businesses they touch begin to flourish as GDP reaches a 6%+ growth rate.

There could well be more rotation out of high-valuation growth stocks that have strong top-line growth, but no earnings to speak of, but what we saw late last week was a very strong appetite by professional money to own the semis during end-of-the-quarter window dressing. That in itself is a buy signal for investors when the market provides opportunities to buy these modern-day industrials on pullbacks.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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