Equity opportunities for the COVID-19 recovery

Investment themes for 2021 and beyond

Key takeaways

  • Low interest rates and a market rotation could boost the appeal of dividend-paying stocks.

  • An increasingly tech-enabled economy may create big winners in tech and beyond.

  • Momentum appears to be growing for a shift toward sustainable energy.

  • On-shoring will bring changes and potential benefits to manufacturers and middle America.

  • Don’t let the market’s recent past dictate your expectations for the future.

COVID-19 has transformed our economy. The evolving landscape presents active equity investors with a range of emerging opportunities and risks. We see four major investment themes for 2021 and beyond:

  • The need for income
  • Digital acceleration
  • Sustainable energy
  • Greater onshoring

In each case, active strategies offer the potential to invest in tomorrow’s leaders, while avoiding the firms likely to lag behind.

Low rates shine a light on dividends

Central banks responded to the pandemic’s enormous economic damage by pushing interest rates to historic lows. One result is extremely low yields: As we approached the end of 2020, the 10-year Treasury yielded just 0.85%, and the Bloomberg Barclays U.S. Aggregate Bond Index yielded 1.17%.1

Yet retirees still need to generate income. Populations are aging rapidly in most developing countries, and people need ways to bridge the gap between their incomes and spending.

With bond yields miniscule, we believe that dividend-paying stocks are excellent options for generating investment income. As a group, stocks with higher dividend yields have lagged lower-yielding stocks by wide margins in 2020 (see Figure 1). This dynamic led to attractive valuations for many companies with the kind of strong, steady payouts prized by income-seeking investors.

Dividend income "on sale"

What’s more, dividend payers would likely benefit from a market rotation into value and cyclical stocks, in which investors anticipating a post-pandemic recovery reinvest in companies that suffered during lockdowns. These companies will have a relatively low bar improving on their earnings in 2021, while companies that thrived during the pandemic will likely face much tougher year-over-year comparisons.

Dividend-paying stocks in the consumer sectors, financials, energy and parts of industrials look likely to benefit most. Investors may want to look in the U.S. and beyond: Europe in particular is home to many high-quality companies that pay strong dividends and could rebound with a global recovery. 

Active strategies can potentially help capitalize on this theme, employing in-depth fundamental analysis to identify firms with the financial strength and business outlook to raise their dividend payments over time.

Digitalization accelerates

Digital technology was spreading rapidly even before 2020, in the form of electronic commerce, a shift to the cloud, industrial automation, and the surge in automobile technology.

The pandemic accelerated this theme, vaulting electronic commerce, video meetings, and other digital-first practices ahead by several years. It also advantaged companies that had taken the lead in harnessing digital tools—like restaurants and retailers that already offered online ordering with curbside pickup, and industrial companies with efficient, tech-enabled warehousing and logistics.

The rise of digital isn’t likely to end with COVID-19. Technology spending currently makes up about 5% of U.S. GDP, and it could go much higher. Moreover, as powerful as digitalization trends already are, many are still in their infancy. For example, only about 20% of the tech workload has moved to the cloud. IT teams may have been reluctant to move important operations to the cloud out of concern that it might prove unreliable in times of stress. Yet COVID-19 provided the ultimate stress test, and cloud computing delivered—potentially making more decision-makers willing to make the shift on an enterprise-wide scale.

Greater digitalization should benefit the technology firms that enable it, but not all will benefit equally. Managers with research expertise in technology can seek to distinguish the biggest beneficiaries from the also-rans.

In other sectors, notably retail and industrials, the companies that make best use of digital technology have potentially given themselves a big advantage in the years ahead. Active strategies with bottom-up research can seek to gauge how well companies harness technology to improve efficiency and capture market opportunities.

Sustainable energy comes into its own

The Biden Administration is expected to hasten the transition from fossil fuels to sustainable energy sources. But the case for sustainable energy isn’t just political; increasingly, there’s also a strong economic case to be made.

Conventional energy sources historically have enjoyed significant cost benefits over solar and wind power. This advantage has dwindled as solar and wind energy have become cheaper, and in the coming years conventional energy may find it more difficult to compete. The combination of improved economics, political support, and the global urgency to reduce carbon emissions could drive growth for many companies exposed to sustainable energy, while presenting new risks to traditional energy and utilities firms. 

Shares of firms related to solar and wind power surged in 2020, so investors may want to wait for a better entry point. Consider adding to exposure on weakness.

A shift from offshoring to on-shoring

U.S. companies have boosted profits over the past 20 years by moving parts of their supply chains to places like China and southeast Asia. The pandemic exposed some risks to that approach, as supply chains for critical items such as personal protective equipment broke down. A more combative relationship between the U.S. and China is also leading some corporate decision-makers to reconsider their far-flung supply chains.

The upshot: We expect to see companies move more of their manufacturing back to the U.S. This trend would alter cost structures for manufacturers and the companies that purchase from them. It also could benefit local economies, especially in the middle of the country. For example, revitalized manufacturing in a city like Cleveland could give a jolt to banks and other businesses that benefit from greater economic activity.

Generally speaking, healthcare and semiconductor companies may benefit most from the trend toward on-shoring. But it will affect individual companies in specific ways, so capitalizing on this theme will require deep, firm-by-firm analysis.

Get back in balance

Growth stocks have dominated the market in recent years, while value has struggled, as shown in Figure 2. That dynamic has caused many portfolios to develop a strong momentum bias.

value vs growth

When investing for 2021 and beyond, remember that market trends change. A strategy that hasn’t worked in the recent past may thrive in the future. Consider balancing secular growth stocks against cyclical, value-oriented shares to prepare for a wide variety of conditions.

Investment considerations

About the author

Bill McMahon, CFA

Managing Director, Chief Investment Officer, Active Equity Strategies