Why it's time to avoid work from home stocks

Sean Darby, global chief equity strategist at Jefferies, joins Yahoo Finance Live to discuss why it may be “time to avoid” work-from-home stocks, which outperformed in 2020 as the lockdowns prevented travel and entire economies were temporarily shut down.

Video Transcript

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JULIE HYMAN: It is time to avoid the work from home stocks, so wrote Sean Darby a week ago today in a note to clients. He's the Jefferies Chief Global Equities Strategist, and he is joining us from Hong Kong right now. Sean, thank you for being here. You talk about the achievement, eventually, of herd immunity because of the vaccination rollout. And if we assume that stocks are six to nine month discounting mechanism, I assume that you think then that's around when we'll be achieving herd immunity, and that's why we should maybe avoid those work from home stocks right now.

SEAN DARBY: Well, they've been fantastic performers. And I think no one could have imagined just how far they've been able to move even during what has been one of the worst economic contractions, the reality is that earnings are always a relative game for the equity markets. And as you start to gain herd immunity, go through that 30% threshold towards the sort of critical 70, 80% levels, the banks in particular will start to see their provisioning levels peaking and impairment charges peaking. And for them, which have been perhaps the most sensitive to the coronavirus, they will start to be able to discount a much better environment for earnings. So in reality, it's about one really big sector, which is the banks and also, to some extent, the commercial real estate coming re-franchised as the worst ravages of the coronavirus begin to peter out. So it's a game of relative performance here, and I think the work from home stocks, whilst still having very good attributes in many cases of the balance sheet, that relative ability to grow earnings is going to come much more difficult.

MYLES UDLAND: You know, Sean, I think that the relative framework is such an interesting one, because people get quite zealous about the value versus growth rotation, what it really means, what it doesn't mean. I mean, it sounds, in a backdrop where financials and real estate are doing well, certainly that sounds like value is going to do well. But do people maybe lose the relative, you know, forest for the trees, as it were. People are too focused on, oh, this is values moment. And it sounds like your point is, yes, its values moment relative to the straw, the amazing performance we've seen from the growth-y names in the last year.

SEAN DARBY: Well, you're right. I think there's been a certain amount of stigma towards value stocks, which is in many respects, not something you should ever do in an equity market, because of course that starts to be the worst moment in terms of the relative performance gain. I think from my point of view, we have to remember that these two sectors are producing very large relative profits for the overall economy, and I think that's really where we're going to sort of see 2021 earnings. It's going to be very much the unloved parts of the equity market that are going to produce some of the better relative earnings. And you know, US equities has always been an EPS revision game, and sometime towards the second half of this year, that's going to be very much the moment for the banks and real estate.

One other thing just, of course, about the banks is that they are the perfect inflation hedge. There's nothing more, no other sector really outside of commodities that tends to do well when the price level in the economy is rising. So again, it's, you know, very much anti-bond trade, and I think that's going to have its place in people's portfolios in terms of a hedge against higher inflation expectations as we go into the end of '21 and into '22 as a recovery gains steam.

BRIAN SOZZI: Sean, you write at length this morning about a quote, "corporate spending binge." For those who are not following this as closely as others, how much cash, exactly, is on the balance sheets of corporate America, and how do you see them spending that cash as the year progresses?

SEAN DARBY: That's a very good point. I think the markets, quite rightly in a sense, have been very distracted by the stimulus package that's going to be forthcoming from the new Democrat party. But in reality, alongside that is going-- you have the corporate sector, which has raised the most amount of money from equity and bond markets in history and where the gross cash level, as a percentage of their total assets for the S&P, is at a record high. So that money can do a lot of things-- it can do share buybacks, it can be used for dividends, it can be used for acquisitions. But I think in the sort of scheme of being in the part of an early cycle, companies will try to deploy that in terms of capital investment.

So it's another sort of lever for economic growth in the US, and one in which, again, it recycles into a lot of the unfashionable parts of the equity market, particularly the industrials and some of the sort of more cyclical industries. So I think initially, people will be very, you know, euphoric about the news of the headline stimulus package from the Democrat party, but that will actually only-- then that will peter out through '21, '22, but the CapEx cycles tend to be of a much longer duration, and I think that's where, again, clients need to start be positioning and aware of just how much money can be deployed over the next couple of years.

MYLES UDLAND: And related to that, Sean, Brian asked about corporate cash, but certainly investor cash has been a big theme in the last decade, really, and you guys had a recent chart showing just the huge surge in inflows to equities over the last couple of months. What role does that kind of money play in the market as we get through and kind of get 2021 really underway here?

SEAN DARBY: Well, it's a very good point. In fairness, that was really part of this big performance move in equities that came about in the wake of the US election and the week of the vaccine news. So there was a squeeze in for this cash to move into equities. But just to put it into a more holistic fashion, last year, money market funds received the most amount of money compared to any of the asset classes that we follow, and there was still $900 billion that was unused in money market funds from a peak of around about 1.4, 1.5 trillion at the height of the pandemic scare.

So there's a lot of cash still sitting that can be used to go into equities as are other asset classes. And by no-- as I say, I think we're still in this period of time for equities where the buy the dip mentality has probably still going to reduce those drawdown risks, which, you know, tend to be much more the late cycle and this one might be much more earlier. You get still quite a lot of money still to be deployed by investors.

JULIE HYMAN: That mentality has been remarkably persistent, hasn't it, Sean? Finally, I want to ask you about international versus US, because there has been a lot of debate about that going into this year and whether people might want to put some cash into international. As someone who sits in Hong Kong and your purview is global, how are you thinking about that question this year?

SEAN DARBY: Well, there's certainly a lot of equity markets that have not followed the same performance as the US, and they have actually been far worse affected from the coronavirus because their economies are very service orientated, a large amounts of tourism. Countries like Italy, Spain, Portugal, Thailand. So I think on the international side, if you think that the vaccine rollout will be successful, then the laggards actually have a lot of room to perform in 2021, and I think there's still actually a very good story there. So yes, US is going to do well, but you could have a group of the laggards that are very dependent on tourism and services actually performing very well as well in 2021.

JULIE HYMAN: Interesting. That thinking goes for sectors and for countries as well, it seems. Sean Darby, Jefferies Chief Global Equity Strategist, thank you so much for your time today. Appreciate it.

SEAN DARBY: Thank you.