Mind the Growing Gap Between Winners and Losers

Jennison Associates’ 3Q 2020 outlook takes a deeper look into strong second-quarter returns and disentangles implications from long-term structural shifts versus short-term stimuli

July 23, 2020

The second-quarter recovery in equity prices was as swift and dramatic as their decline from February 19 to March 23. Perhaps even more remarkable was the number of stocks that closed at record highs on June 30. The logic in the market’s bifurcation between winners and losers in a COVID/post-COVID environment has lifted advantaged companies and industries to fresh records, while beleaguered companies with bleak prospects for recovery have seen equity values atrophy.

Having lived with the disease for some months now, we can better gauge its primary, and in some cases, secondary effects on economic activity and behavior. Consumers have altered their approach to daily life as work from home leads to greater e-commerce engagement, increased demand for food and grocery delivery, rising spending and investment on dwellings, and faster adoption of streaming media, fitness, and entertainment with attendant needs for robust internet infrastructure. The transformation of work is equally notable and starts with the same necessity of robust connectivity. Face-to-face meetings, business travel, and office needs are being reimagined, giving rise to Zoom, cloud-based telephony, and remote working. Jennison Associates is working diligently to understand the opportunities and threats given the vast implications of these structural shifts.


Earnings backdrop

It is still too early in the crisis to make precise estimates of companies’ earnings through the rest of 2020. This level of uncertainty is historic as is the extreme market volatility that comes with it. Almost all companies (across sectors and industries) have withdrawn forward estimates and guidance for the remainder of 2020. For most companies, there are too many unknowns around economic activity, unemployment, rates, defaults and credit losses, drastically lower consumption and business spend, destroyed consumer and business confidence, and the financial hit to both businesses and consumer balance sheets. While recent datapoints indicate multiple “green shoots” for both domestic and global economic activity, top-down projections for the S&P 500 Index in 2020 continue to coalesce around -20% to -30% earnings growth, dividends projected to decline by 25%, and the suspension of most stock buyback programs. Again, it’s important to recognize that these are early stage guesses at best.


Equity sector views at a glance

Consumer discretionary was the best-performing sector in the quarter, followed closely by information technology. Information technology remains the best-performing sector year to date and over 1-, 3-, 5-, and trailing 10-year periods, maintaining its leadership even with the sell-off and volatility. In the quarter, defensive sectors such as consumer staples, utilities, and real estate lagged as did cyclical sectors such as financials and industrials. Despite strength in the second quarter after a sharp sell-off in the first quarter, energy was the weakest sector across longer time periods.



Sector Outlook
Information Technology Information technology was among the better-performing sectors in the S&P 500 Index in the second quarter, advancing 30.5%. In tumultuous environments such as the current pandemic, innovative technologies take root and typically gain significant market share. Given this dynamic, Jennison believes technology-related stocks will extend their decade-long market leadership, supported by reasonable relative valuations that continue to be driven by the sector’s overall stronger ROEs and free cash flow generation, often as a result of innovative and disruptive product offerings. With accelerating adoption of cloud computing, digital business-to-business applications, and online retail, health care, education/learning, and business services, technology-related company earnings are driving overall earnings growth globally.
Health Care In the second quarter, the S&P 500’s health care sector rose 13.6%, underperforming the overall index, which advanced 20.5%. The relative prospects of health care companies in the midst of the COVID-19 pandemic vary by industry and individual company fundamentals. While biotechnology, life sciences tools, and medical devices demand have been resilient, hospital companies have been significantly hurt and new patient starts could be delayed and drugs used for acute illnesses or administered by physicians could be disrupted. The outbreak has also given rise to what Jennison believes is a sea change that could permanently modify health care benefits, treatment, and consumer behavior. In the current environment, people are now seeking out telemedicine services, and insurance plans are waiving co-pays and coinsurance for those that utilize it.
Financials The S&P 500’s financial sector continues to lag the overall market and is one of the worst-performing sectors. The drastic fall in interest rates and uncertainty around credit quality has affected both fundamentals and market expectations. Overall, banks are significantly better positioned today than they were in 2008-2009 across a broad range of balance sheet, capital, and risk management metrics. While the drawdown has been extreme, it appears that significant “bad news” is being reflected in current stock prices. Jennison has higher confidence today in reported book value metrics and thinks the sector may possibly be oversold. Secular growth companies with defensive attributes (low leverage rates, asset light models, sustainable, high margin, and high free cash flow businesses) should continue to fare better in this type of environment. Several digital payment and financial technology companies meet these criteria.
Midstream Infrastructure The Alerian Midstream Energy Index was up more than 30% over the second quarter as the sector rallied off the bottom from last quarter’s unprecedented and simultaneous oil supply and demand shocks. As the U.S. economy activity slowly ramps up, Jennison remains optimistic given the significant transformational corporate reform that has been occurring in the midstream sector over the last two years, which was already having long-term positive benefits. And while it’s difficult to predict short-term outcomes, over the longer term, Jennison believes the large, integrated, reformed companies will survive. While the demand for energy hydrocarbons may slow, Jennison does not believe it will end. It believes that midstream infrastructure companies have physical steel “in the ground,” many with asset networks that have high barriers to entry and are difficult to replicate.
Utilities As U.S. economic activity started to ramp up over the second quarter, investors began focusing their attention away from utilities and into more cyclical and growth-oriented sectors levered to a recovery. While market participants continue to focus their attention on the impact to power demand from the COVID-19 pandemic, Jennison does not believe electricity demand is a “needle mover” to a company’s profitability. By and large, the COVID-19 pandemic’s impact to the overall utility sector is likely modest to nil, and is unlikely to affect the longer-term earnings power of the sector.

For more details, read the full Market Review and Outlook, which is available for financial professionals.


The Alerian MLP Index is an unmanaged index and the leading gauge of energy master limited partnerships (MLPs). The capped, float-adjusted, capitalization-weighted index constituents represent approximately 85% of total float-adjusted market capitalization. The S&P 500 Index is an unmanaged index of 500 common stocks of large U.S. companies, weighted by market capitalization. It gives a broad look at how U.S. stock prices have performed.

The views expressed herein are those of Jennison Associates investment professionals at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. Neither Prudential Financial, its affiliates, nor their licensed sales professionals render tax or legal advice. Clients should consult with their attorney, accountant, and/or tax professional for advice concerning their particular situation.

Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy.

Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated, based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.


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