This is a crucial moment for the Invesco S&P 500 High Beta ETF (SPHB). The fund has been on an impressive winning streak. For the month of November alone, fueled by the end of the election cycle and back-to-back positive news on the rollout of a coronavirus vaccine, SPHB has been up an impressive 27% – a whopping 20 percentage points more than the S&P 500 (SPY).
To find out if high beta stocks might be a smart play at current levels, I looked at the issue from a bearish and bullish perspectives. On the one hand, high beta has yet to sustain outperformance over the broad market for an extended period of time in 2020. On the other hand, recent momentum could merely represent the first move higher in cyclical stocks, which one might reasonably expect in the early stages of the COVID-19 recovery process.
(Image Credit: Michał Parzuchowski @ Unsplash)
The bearish case
Before moving on, I would advise readers to check out my brief summary on the S&P 500 High Beta ETF, which I published in June 2020. At a high level, SPHB is a large, fairly liquid fund that invests in 100 stocks within the theoretically riskier and more pro-cyclical sectors that include financial services, consumer discretionary and energy.
Back in early June, I argued that SPHB had climbed a bit too far, a bit too fast. In my view, at least relative to the risk exposure, I did not feel particularly enticed by the return potential in high beta, especially given so much uncertainty regarding the duration of the pandemic and the intensity of the recession. Lo and behold, high beta stocks peaked the very next trading day, and they pulled back by about 17% over the following three weeks.
Now, the scenario is definitely different. Multiple vaccines are about to hit the market. Emergency use of Regeneron’s (REGN) COVID-19 treatment has been approved. Still, it concerns me a bit that SPHB has just climbed above the S&P 500 in 2020, as the chart above depicts. The only other time that something similar happened this year, the ETF came crashing back down fast, as COVID-19 cases spiked in the summer – as they may again in the winter.
The bullish case
On the other hand, the valuations of some of the top names in the ETF are still well off their peaks. Take these three among the top ten holdings in the fund:
- Norwegian Cruise Line Holdings (NCLH) – Trailing P/E 2.5x today vs. 12.5x last year
- PVH Corp. (PVH) – Trailing P/E 9.7x today vs. 12.0x last year
- Darden Restaurants (DRI) – Trailing P/E 15.0x today vs. 20.0x last year
Notice that these highly cyclical names, and possibly many others, still have quite a bit of fuel to burn – at least judging by how much further their valuation multiples still need to climb to return to something close to a pre-pandemic normal.
Also note that, between the Global Financial Crisis and the 2020 pandemic, high beta has lavishly underperformed the S&P 500 (see chart above). Therefore, the slightly superior results in cyclical stocks this year may not mean much once we take a step back and appreciate the bigger picture.
Perhaps the recent gains in high beta are only the beginning of what could be a longer-lasting recovery ahead of the early innings of the next economic expansionary cycle.
Buy or sell?
Of course, I have no way of telling for sure whether high beta will build up on its robust November performance. Instead, I prefer to have a balanced view on SPHB, distinguishing short-term expectations from long-term prospects.
In the immediate future, I find it reasonable to think that the ETF could pull back as investors cash in some of their chips following an outstanding three-week run. But looking further into 2021, I think that this may be the best time to bet on “old economy”, cyclical, high-beta stocks once again – an idea that I defended when I wrote about the Dow Jones index a couple of months ago. While the upside opportunity may have shrunk quite a bit in the past few weeks, I believe that hefty gains have yet to be realized over the next several months.
A helping hand
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.