The Stock Market Is About To Flip

What's down you guys? It's Graham here.

So, as we start off the new year of 2021, we have to talk about something that's been brought up a lot lately, especially now that the stock market is near its all-time high, and that has to do with our stock market completely flipping when our economy reopens.

Now, typically when I see articles calling out for the great stock market rotation, I'll just give them a quick glance over, chalk it up to normal fear-mongering, and then I can make a video calling them out and trying to disprove whatever they're peddling. But this one is different. In fact, the more I looked into the great stock market rotation, the more I actually started to agree with it. Plus, a lot of the analysis that I'm about to bring up here makes perfectly logical sense when you start digging deeper, which is not something I would usually say when I'm referring to a MarketWatch or Business Insider article.

Now, I don't want to alarm anyone into thinking that our entire economy, as we know it, is about to collapse any day now, but the stock market flipping around is something worth mentioning. This has the potential to impact your investments in the near future and where we see demand going over the next 12 months, or at least it's interesting enough to me. But then again, my hobbies lately have included doing research like this and then bidding on Pokémon cards on eBay, so maybe there's a small chance I have completely lost my mind or not.

But either way, here's what's happening with a potential stock market flip, what this means for you, and then how you could use this information to make money. But of course, as usual, I'm going to need your help to flip that like button for the YouTube algorithm by making it turn blue. I have a $20 bet going on with my podcast co-host, Jack, that we could get this video to 69,000 likes, and I really don't want to lose $20. So, if you wouldn't mind helping me out just by slapping that like button, it would help me out a lot and help me win. So, thank you so much for doing that, and with that said, let's start the video after this really cool transition. Look at this! Look at what I can do now—boom! So, there we go.

To bring you up to speed, here's a quick rundown of what's happened this year because in order to understand why the experts are calling for the stock market to flip around, we have to understand how we got here.

When our economy shut down in March, stay-at-home orders were put into effect and businesses had to close up. We saw a massive stock market plunge across everything. People panicked; they pulled out of the market entirely. They stocked up on cash and food and hoards of toilet paper, and then they took more of a wait-and-see approach with their money while they patiently waited for Congress to pass their first stimulus package.

However, something interesting happened just weeks later. Companies like Amazon, Shopify, PayPal, Zoom, Facebook, Snapchat, and nearly every other digitalized product or service saw a huge spike in the stock price. That's because as brick-and-mortar businesses were forced to shut down and people were forced to stay inside, investors turned to digitalized products and services instead, thereby driving up their price.

There was also a mass exodus of money turning away from businesses like restaurants, airlines, travel, and so on because for many investors, those were deemed to be too risky during a time where no one was traveling and very few people had discretionary income to spend. Well, from that, there was definitely a big move away from hard-hit companies like that, and that money needed to go somewhere. So, it went to tech.

Now, some people could argue that yes, over the last 10 years there's certainly been a natural push towards digitalization—cashless payments, online banks, remote work, and food delivery—but this illness caused that change to flip suddenly overnight. That happened to cause a very large imbalance between the companies who just so happened to be perfectly positioned for such an opportunity and the harder-hit recovery market, which is still very much lagged behind everything else.

I pointed this one out in the past—when the S&P 500 hit its all-time record high, much of that growth was actually driven by the top few largest tech companies, which had the biggest weight within the index simply because they were the most valuable companies. For example, if you look at the breakdown of the S&P 500 over the last 12 months, you'll notice that only one-third of the stocks within the entire index are positive for the year. That means the other 300 companies in the S&P 500 are trading lower today than they were a year from now. And despite two-thirds of those stocks being lower today, the S&P 500 continues going up. Why is that, you might ask?

Well, the S&P 500 is largely weighted towards big tech and Tesla, so any move for big tech and Tesla is going to move the entire index alongside with it. As a visualization, so you can see what's going on here, the blue line tracks the top 10 biggest stocks in the index, and the orange line follows the other 490 companies. As you can see, overall, the biggest companies are significant enough to pull up the other 490, which still have not recovered from their price last year.

Okay, so maybe that was a longer explanation than I originally anticipated, but at least I'm thorough. And now, this is why we lead into today and why so many people are calling for a stock market rotation.

This all starts with two terms: growth stocks and value stocks. A growth stock is a company that has the potential to outperform the market because of the rapid growth and expansion. These could include companies like Amazon, Apple, Facebook, Google, and the big names which have largely already led the market. But then, on the other hand, we have value stocks. These are the companies that are believed to be trading below what they're actually worth, and because of that, they have the potential to bring you larger returns.

For example, a value stock might include a company like General Motors, Verizon, or PG&E. So far in 2020, value stocks like this have been hit very, very hard and have been largely overlooked for their investment potential. But now, according to some of these articles, we're in a very early transitionary period where money could be shifting away from big tech stocks and into recovery stocks, as investors try to capitalize on the vaccine and our economy reopening.

Like a Bank of America analyst predicted, we're in an early inning of an upcoming value cycle and that the relative discount for value stocks remains nearly two standard deviations below average. Basically, what they're trying to say is that big tech is very expensive; it might not climb even higher than it already has, and everything else relative to that is undervalued.

Goldman Sachs also agreed with this, saying that the market is due for a large but temporary rotation out of growth stocks. Now, according to them, since the great financial crisis of 2008, there have been 15 rotations into cyclicals and out of defensive, safer stocks. On average, these rotations lasted for four months and resulted in 15% outperformance for cyclical stocks. However, they still remain neutral on tech stocks, acknowledging that they make up a large part of our economy and that they're here to stay.

Now MarketWatch covered another analyst who said that the market rally up to this point has been supported by companies that are more resilient to socially distant uncertainty, like with Zoom. But a future rally is most likely to include a combination of both recovery and e-commerce, and future gains are likely to be more balanced. Lastly, JP Morgan also repeated the same thing for 2021, saying that value stocks are poised to outperform once the virus is contained and the global economy fully emerges from restrictions and fear.

Or really, in other words, all you need to know is this: the consensus among analysts is that when our economy reopens, there's going to be a big shift of money away from big tech stocks and into hard-hit recovery stocks as investors try to get a quicker return and try to find something that's undervalued. Some say this has even already started happening, like in November. Energy, transport, and financials saw a huge boost with anticipation of a vaccine, while tech fell.

So, just as fast as money went into tech, the thinking is that that money could go back into airlines, restaurants, travel, hospitality, and so on, many of which are still trading below last year's price, thereby driving them back up.

Now, when it comes to this, rotations are really nothing new. The 1990s saw the tech boom before losing 75% value, the 2000s saw the real estate boom before also collapsing in price, and the 2010s just saw the tech boom again with tech prices going even higher. So, in the bigger picture, what we're experiencing today is relatively normal.

But given the abrupt changes to our economy that pretty much happened overnight, we could very well see some permanent changes to our economy that would cause some businesses just to continue declining. For example, it's been estimated that 42% of jobs lost are gone forever. A large portion of the population is going to continue working from home. A lot of us grew accustomed to the convenience of online shopping or choosing Zoom over in-person meetings, and that is unlikely to change even when we do reopen.

Now, I don't think this means we'll never go into an office again or we're never going to step foot in a grocery store because Amazon could just deliver the food to your front door. But I do think there's a certain level of change to our economy that's not going to be reversed.

It's too early to tell just how much is going to return to normal once a vaccine is widely distributed, but it's not out of line to think that oil, restaurants, hotels, and travel might see a big push once things start to get under control again. The risk, however, is that things like this are very difficult to time. We don't know how much of this is already priced into the market, or how much pent-up demand there will be, or how long investors will sit on the sidelines just to wait things out and see what happens.

We also don't know if big tech will just continue dominating and leading the way or if we could see lower returns that would bring down the average of the entire S&P 500. We also still have a long ways to go. There's a confirmed new case of the illness that's made its way to the U.S., and it might very well be a long 2021 before things start to return to normal.

That's why it's still extremely risky to go and buy hard-hit recovery stocks like airlines, hotels, and restaurants and so on, without the understanding that there is no 100% guarantee those stocks are actually going to do well.

But in terms of what you could do about this information, I do agree the great rotation is a valid argument. I think it's natural that once a vaccine is offered, there is going to be pent-up demand for people who want to travel, eat out at restaurants, and do things they normally did.

I do think that would greatly benefit the companies which have been shut down or have been operating in a much lower capacity. Although, at the same time, we have to acknowledge that tech is not going anywhere and our economy is so reliant on those products and services that we use day-to-day. It's not like we're going to snap our fingers and then never order from Amazon ever again.

In fact, now, if I had the choice, I would just order everything online and then never have to leave the house ever again.

So, in terms of my overall recommendation here, I'm not just going to tell you to buy and hold the S&P 500 and that's it, because that's what I say every time. I want to make this more exciting and really leave the choice up to you.

So here’s what I have to say: first, if you want to buy hard-hit recovery stocks like airlines, restaurants, energy, oil, and so on, it's very high risk, high reward. But it also is very important to understand that just because something today is trading below what it was a year ago, that does not mean automatically it's got to return to that price or that is how much it's worth. Demand has changed, and we're not sure how much is coming back. Many of those companies have taken on a lot of debt, and it very well could take a long time for those companies to recover, if ever.

On the other hand, in the short term, you could do very well if you pick the right ones. So, as a very speculative high-risk, high-reward play, this could pay off.

The second option for less risk is to take a more balanced approach and invest in an overall index or ETF. The Russell 1000, for example, follows the top 1,000 publicly traded companies in the United States and tends to skew towards large-cap stocks. This would weight your investments slightly differently than the S&P 500 but not enough to miss out on tech if tech continues to do well.

And third, you could just continue investing in the S&P 500 and letting the leaders continue to lead. And that's it!

Now, there has been continual talks about the concern of the S&P 500 being weighted too heavily within just a few very large companies, and there's certainly a risk to that. But there's also a risk that you miss out on those gains if those largest companies continue to do really well.

So overall, my thought is that yes, I do think there's a valid argument that could be made for recovery stocks, and I do think yes, once we return back to normal, there's going to be a lot of pent-up demand for travel, eating out, going to restaurants, and so on. I think it's just human nature to want to go to the Cheesecake Factory and order miso salmon because it is so delicious.

So, we do think there's opportunity for reopening; however, it just comes down to the risk you're willing to take and how sure you are that the companies you pick will actually recover.

For me, I've diversified a little bit into recovery stocks, but still, the bulk of it is going into the S&P 500 consistently, and that's it. My thought is that if tech stocks go down, recovery stocks go up; that should balance each other out. And if tech keeps doing well alongside recovery stocks, then that's good for my investment.

Of course, the biggest risk of this is that everything goes down in which case I would just keep buying lower. But I don't think this would be severe enough to change a long-term investment strategy for me.

I think the great stock market rotation is interesting; it makes a lot of sense, and it's a valid argument. But is it worth the risk? I would argue for most people probably not, and it's probably worth sticking with your normal investing plan as usual. And that's it!

It's good information to know, and it's gonna help you understand how index funds like this are weighted. But I wouldn't worry too much about it. Big tech, I believe, is still here to stay.

And now, at least when you hear about the great stock market rotation, you're gonna understand what it means, how it applies to you, and how it helps you smash the like button for the YouTube algorithm.

So, with that said, you guys, thank you so much for watching. I really appreciate it. As always, make sure to destroy the like button, subscribe button, and notification bell. Also, feel free to add me on Instagram—I posted pretty much daily, so if you want to be a part of it there, feel free to add me there.

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Thank you so much for watching, and until next time!