Value stocks rally has long legs -strategist

O'Neil Global Advisors Chief Investment Officer Randy Watts tells Reuters' Fred Katayama why he thinks value and cyclical stocks will keep outperforming growth stocks for another six to 12 months.

Video Transcript

FRED KATAYAMA: An across the board sell-off on Wall Street Tuesday, led by the Dow, amid inflation concerns. Let's get some views on the market from Randy Watts. He's chief investment officer at O'Neil Global Advisors. Hello, and welcome back, Randy.

RANDY WATTS: Hi, Fred.

FRED KATAYAMA: So we're seeing a global sell off today, the S&P 500 dropping to a one-month low, the VIX volatility index soaring to a two-month high. The NASDAQ already corrected in March, but are you seeing any signs that leads you to believe that, hey, a correction is in the offing soon for the S&P 500?

RANDY WATTS: I would say a couple of things. First, in terms of the global picture, the markets have been very strong. The Vanguard All-World Index, which encompasses all the stock markets around the world, is above its old high from early 2020 by about 25%, and it's up about 90% from its March low last year. So we've had a huge move in the market.

With regards to the US market, we're seeing a dichotomy. If you look right now, about 75% of the S&P is above its 50-day moving average. But when you look at that for the NASDAQ, it's only about 29%. So there's been a big split between the S&P and the NASDAQ, and I think what that relates to is a rotation into value and cyclical stocks.

FRED KATAYAMA: All right.

RANDY WATTS: The NASDAQ recently-- sorry-- broke its 50-day moving average. And so I think the question is for investors, does that portend a deeper correction for NASDAQ, and is the S&P going to follow that?

FRED KATAYAMA: And how do you see that developing?

RANDY WATTS: I think it's likely we will have a bit of a pullback here as we enter a seasonally slow time for the market. We've gotten through earnings season. There could be a little bit of a lack of news for the next couple of months. Normally, the market's slower in the summer. However, I still think there's a lot of room on the upside for this market between now and the rest of the year, and I think what's really going to be driving that is that there's so much capital still coming into the economy.

The Fed is buying about $120 billion of bonds a month, so the Fed is still being very easy and it's trying to keep rates low. And the government is just starting to spend the fiscal stimulus money from the Biden plan. A lot of that money is going to flow out to the public, and I think inevitably some of that money is going to work its way into the stock market.

FRED KATAYAMA: Randy, you mentioned the dichotomy between the NASDAQ and the S&P, between cyclical stocks and tech stocks. Tech stocks have reasserted themselves in April, before value took over the lead again in May. Given the run that value stocks have had since last year going through March, and yet again this month, how much longer can value cyclical keep outperforming growth in tech?

RANDY WATTS: When we look at past cycles, what really drives the cycle is when earnings growth accelerates broadly. We're not that many quarters past the bottom of the profit cycle. I think this has got at least another 6 to 12 months yet to go. Right now, energy and financials are doing very well. I think, as I mentioned earlier, as that money comes into the economy, that's going to further stimulate growth. So I think the value team is going to remain leading for a little bit while longer.

While I like large cap tech on a long-term basis and I would be looking for points to enter the stock selectively, I think it's a little bit too early to abandon the value cyclical trade and rotate back to growth.

FRED KATAYAMA: Then if you have money on the sidelines, what value stocks or cyclical stocks do you suggest they put them in? That are--

RANDY WATTS: You know, we still like a lot of the financials, and they all had great quarters. And the yield curve is very steep right now. It's about 146 bps between the 2 to the 10-year spread. So we like Goldman Sachs. We like Morgan Stanley. We like JP Morgan, which is obviously a leader in banking. We like First Republic in the mid-cap space.

So I still think financials have a ways to go. They underperformed for years. They've just gotten going the last couple of quarters. I think that can play out positively for the rest of the year.

FRED KATAYAMA: All right. So keep an eye on financials. Thanks a lot, Randy

RANDY WATTS: Thanks, Fred.

FRED KATAYAMA: My thanks to Randy Watts of O'Neil Global Advisors. I'm Fred Katayama in New York. This is Reuters.