The more volatile the stock, the better the performance this year. That can’t continue for the near term.
So-called high-beta stocks, those that are typically more volatile than the broader market, have been the brightest shiners to start what has been a solid year. The
is up about 8% for the year, but high-beta stocks are up more.
Some of those are economically sensitive, meaning that the companies’ sales and earnings fall and rise faster than average when the economy stumbles or booms.
Others are fast-growing technology companies that are risky because much of their expected earnings are forecast to come many years in the future. Investors are willing to pay a lot for those future earnings, so the stocks’ valuations—prices relative to near-term earnings—go sky-high. Rising interest rates reduce the current discounted value of those future earnings, reducing the amount people are willing to pay for the shares.
Both kinds of high-beta stocks were hit hard as the Federal Reserve raised interest rates last year. Investors worried about slower growth hurting economically sensititve companies, while higher rates slammed growth stocks.
The reason for this year’s high-beta rally comes down to interest rates as well. The market expects that the Federal Reserve will soon pause in raising interest rates because the rate of inflation is declining, and higher rates are meant to lower inflation by reducing economic demand.
If rates stabilize, or even decline, economic growth will recover, the thinking goes. That would be good for economically sensitive companies, while lower rates would increase the current value of future earnings, boosting prices for growth stocks.
A basket of high-beta stocks tracked by
has shot higher this year, helping it to outperform the
by more than 20 percentage points since the end of 2017, according to Wells Fargo. When the basket outperforms by that much, it reaches “overbought” territory and promptly starts lagging behind, according to the bank.
“The risk “bounce” makes some sense given the lower-rate environment, a higher probability of a Fed easing cycle,” wrote Chris Harvey, chief U.S. equity strategist at Wells Fargo. “Expect a near-term reversal.”
Many sectors have had significant gains.
Airline stocks, for example, have taken off. People travel more when they have more discretionary income, and growth in consumer spending could bottom out, then recover, if the Fed pauses soon.
(JBLU) is up about 34% so far this year, while United Airlines (UAL) is up 33% and
American Airlines Group
(AAL) has gained 32%.
Homebuilders, meanwhile, stand to gain if lower rates make housing more affordable. The home construction company
(PHM) has seen its stock gain about 22% this year. That recently brought it to a roughly 25 percentage- point outperformance versus the S&P 500 since the end of 2017, a level of outperformance it can’t seem to surpass. Peer Lennar (LEN) has seen its stock rise 13% for the year.
Metal mining stocks have also raced higher as investors price in an eventual recovery in economic and manufacturing growth. The price of copper has gained, while shares of
(FCX), a big copper producer, are up 13% for the year. That brings the stock’s cumulative outperformance versus the S&P 500 to more than 50 percentage points since the end of 2017, a level where it tends to top out, according to Wells Fargo’s research.
Within high-growth technology,
(NVDA) jumps out with a gain of almost 60% for the year. Analysts expect per-share earnings for the chip company to grow almost three times as fast as aggregate profits for the S&P 500 over the next three years, according to FactSet.
Those future earnings are why Nvidia trades at about 50 times the earnings per share Wall Street expects for the coming year, far more than the S&P 500’s roughly 18 times. When rates fall, those coming profits are woth more, and the stock jumps.
The problem now is that many of these stocks are already starting to flatline. Staying on the beta-stock sidelines makes sense for the present.
Write to Jacob Sonenshine at email@example.com