Looking for the Lag Trade

This report will look at the lag trade, seeking stocks that have yet to recover from Covid or paused long enough to resume their advance. Before we share that list we would note that the stock market as a whole is once again pushing into an area of high risk for a potential correction of 10 to 15%. It has been a fools errand timing corrections in this super charged Government stimulated Bull market over the past 15 months, but we will offer our warning to new investors and traders to avoid new buy side entries with indices edging into record high territory as sentiment indicators (green line) jump back into the overbought zone. While a maximum technical target near 4450 basis the SP 500 Index (5% higher) can be projected upon a decisive breakout to new highs in all the indices this summer, we now have risk of another initial 5% decline, like we experienced in early May and growing risk of a dip below the 200 day moving average in the upper 3700’s (11% correction). The stocks mentioned below are laggards with more growth potential if Covid continues fading, but of course a general market correction would offer more ideal entries to buy.

Often the first year of a Bull market is so strong for all stock sectors that analysts describe it with adage, “A Rising Tide Lifts All Boats”. In the current Covid recovery Bull market, some stocks figuratively and literally remain docked in the harbor, while others sailed far ahead of the armada with record growth, especially while the economy was shut down. For almost 12 months from the March 2020 nadir in the stock market, demand for productivity and remote work pulled forward several years of demand for technology companies. As Tech plateaued, the broader cyclical, small cap and value segments joined the Bull market last November. Energy, Material, Industrial and Financial companies from this group have now run up to premium valuations along with Tech. All of these leaders can resume gains in their stock once they have time to grow revenues into their elevated  prices. However, some stocks have yet to experience their walk of fame despite strong growth and others have yet to be permitted to have any sales at all due to Covid mandates. Let’s look at some laggards that may have more room to run than the winners of yesteryear.

Travel  can be a broad category that has clearly lagged. While tech stocks have long surpassed their pre-pandemic capitalizations,  the travel sector has underperformed due to mandates and vaccine penetration requirements. Cruise lines have been forbidden from making money for over a year now, awaiting permission from countries to begin service post vaccine. The big three, Carnival, Royal Caribbean and Norwegian have stair stepped their stocks higher 300 to 400% from their pandemic lows, yet they remain 45 to 75% beneath their highs reached just before the global lockdown last year. Carnival Cruise has bookings for 2022 above their 2019 levels already. In May, our favorite, Norwegian (NCLH) reported its best initial booking week in its 54-year history and Norwegian Prima (its newest ship) became the most in-demand ship ever for the cruise line. With a current stock valuation at 12 times forward projected sales, we still feel NCLH has a minimum upside of about 35% from here into the 40’s. Technical chart potential for the mid 50’s to mid 60’s over the next 15 months is plausible if Covid is contained.

Airlines have had a more gradual glidepath higher as passengers could increasingly fly with fewer restrictions and virus fears. One could throw a dart at the major airline stocks and find almost identical gains this past year of 65 to 75% among the majors. Our pick of United Airlines (UAL) last year is still about 70% below its 2020 pre-Covid high. UAL just ordered 200+ new planes this week and has announced restarting 16 routes as well creating 9 new routes to accommodate the surge in bookings. Additional signs of a resurgence are the workers going back to offices in higher volumes, which will boost the key high profit business travel component. Air cargo business is also rebounding this year. With air travel having improved this year from 66% below 2019 volumes to just 33% today, we expect above normal travel ahead that allows for continued revenue momentum in these travel stocks.

Boeing (BA) is another travel related stock that has endured countless stumbles in the year before and during Covid. As airlines increasingly announce massive new airplane orders over the next year and as passenger traffic leaps to above normal volumes in coming months, the stock has room to run up to and beyond the full global travel and leisure reopening point it has experienced before. BA is still down 40% from all time highs and its forward price to earnings (PE) 27 is well below the overly exuberant 56 PE hit in late 2019. A stock appreciation of 60 to 80% from here would be needed to reach the price peaks of 2019 and 2018 respectively. Boeing has yet to experience a period of competent management and turbulent free operations these past 2 years, but pent up demand is only in the early innings of being realized with accelerating order flow and a rising backlog cycle. While our hypothetical portfolio purchases under 200 last year offered high confidence long term value, the 240’s today targeting mid 300’s over the next year continues to offer opportunity with earnings revisions expected to appreciate.

Physical property sector is another laggard that is increasingly attracting investors. Property owners like Simon Properties (SPG) and Federal Realty (FRT) are rising quickly, but remain 12 to 29% under early 2020 levels. While the US is over Malled, these mega managers of realty have room to run back to their 2019 highs with the pent up surge expected in actual stores, bars and restaurants that are in the early innings of in person spending and socializing post Covid. While anchor stores like Macy’s could have a bit more room to catch up, depressed chains like Ollie’s Bargain Outlets (OLLI) should eventually see their armies return them to their prior high growth trajectory. Ollie’s opened 46 new stores last year during the pandemic and plans 50 more this year. These surplus and close out sale discount stores now number 406 and often locate strategically in rural areas where they can dominate, as Walmart did in their early years. With the stock down almost 25% from its peak last summer, Ollie appears to offer value for investors as well as shoppers.

Clothing retailers are still thought of as laggards in this market despite their run, as sales numbers are expected to accelerate. Back to school shopping is a much bigger impulse this year than ever before after a year of virtual learning. As the economy reopens with record savings and extremely strong consumer balance sheets, it’s expected to propel this sector for the next few quarters. VF Corp (VFC) and many apparel stores (AEO, TJX…) should benefit from the huge savings pool and pent up back to school traffic with strong pricing power and profit margins.

Another high growth company related to the travel space that investors have partially ignored is Thor. Recreational Vehicle (RV) parks have surged and backlogs of RV’s will take well over a year to satisfy before dealer lots can be restocked. Backlogs are up 550% from a year ago and by over a third just this year. Sales are growing at roughly a 60% rate, limited by a lack of labor that should extend this cycle. With a Price to Sales ratio of less than one, Thor has some clear roads ahead for at least the next year and beyond with the tailwind of aging demographics favoring the RV lifestyle. Thor is above above pre-Covid levels, but down almost 25% from recent highs and trading where it was last summer before backlogs soared much further.

The record US capacity constrained supply chains unable to handle surging order volumes have boosted one of our favored group in goods transport. Trucking and train stocks remain strong, but richly valued. Norfolk Southern and XPO Logistics trucking are still in our recommended holdings, but the only shipping company we have that offers more of a discount for new investments is Marten Transport trucking (MRTN). MRTN has much lower multiples than its competition along with 20% growth in operating cash. A lack of drivers inhibits all trucking company growth rates, but improved technology tracking at MRTN and higher dividends with its stock consolidating for over a year at current levels, offers more value here than its competition. 

Live entertainment stocks have been enticing in that they have had almost no revenue for over a year, yet confidence is essentially 100% that they will rapidly return to full in person attendance this year. Many of the hotels and concert stocks, such as Wynn Resorts and Live Nation, have already appreciated above pre-pandemic levels. A couple that have more capacity to be realized are Las Vegas Sands (LVS) and Madison Sq Gardens Sports (MSGS). MSGS would need a 75 to 80% rally and LVS about 35% to regain their peaks just prior to Covid. Given the pent up demand to travel and be entertained along with Government handouts and modest forward multiples, there is a case to be made for surpassing 2020 valuations.

Cyber security stocks were not laggards in 2020 and are a special theme sector on a secular growth path enhanced by ever increasing ransom attacks and intellectual property (IP) theft. The world war of cyber is gradually being labeled as such as Western Governments are finally waking up to the hundreds of small cells or state sponsored cyber warriors that can severely harm cities and nations with loss of property and lives. Legacy security firms protect millions of companies and individuals from physical attacks, yet the cyber risk today is greater and the lack of defense is shockingly inadequate. Palo Alto (PANW), Cloudflare (NET), Fireeye (FEYE), and Zscaler are great solutions in this sector. However, we will highlight 2 that are almost as richly valued as their competition: Crowdstrike (CRWD) and Mantech (MANT). They should remain fast secular growers. CRWD has superior end point protection as well as a 50% revenue growth rate and has added 1,500 new customers in Q1.  It has been consolidating for over 6 months and appears poised technically to move into the upper 200’s to low 300’s later this year if the cyber wars intensify. Liability risks will become a higher priority in Board rooms and the Government that will demand an end to IP theft and ransoms.

 An offshoot of the cloud security sector is ManTech (MANT). MANT is a cheaply valued technology concern with expertise in engineering, software development, cyber security network architecture, intelligence support, and critical IT and infrastructure protection. Its focus is securing Government and military operations. Spending more on cyber defense and adopting a counter offensive attach posture appears to be an easy budget item for both sides of the political isle to approve as Government realizes how far behind they are in this increasingly public battle. MANT is a slow growth company that has been consolidating for over a year and should see some acceleration over the next couple of years.

The payment platform companies Paypal and Square are the most widely owned and expensively valued providers. However, there are a slew of small cap fast growing providers that we favor for investing. While Ncino (NCNO), Afirm (AFRM) and and Aci Worldwide (ACIW) all have upside potential this next year as businesses reopen, our favorite small cap payment platform companies are Pay Safe (PSFE) and Repay (RPAY). They are trading at 6 and 11 month lows with more reasonable valuation multiples in their segment, yet showing rapid growth. The caution near term with PSFE is that it’s a SPAC. As we have noted earlier, the SPAC bubble in general swelled in 2020 and bust recently, thus Pay Safe and others are out of favor at the Wall Street Fashion Show this quarter. If PSFE can clear resistance in the 13 to 14 zone it would be a strong sign that investors are once again willing to pay for growth. Repay is also a SPAC, thus patiently buying the pullbacks near prior support is advisable.

There are other lag trade stocks that will materialize during the next general market correction of 5 to 15% before year end and a return of many FANG and fast growing tech names like Service Now and Amazon will resume their trends back to record highs once the reopening stocks have matured. We have talked about a broader corrective period in the stock market in May that could extend into late June if the current testing of record highs this week fails. Look for a possible breakdown to invest excess cash in the oversold stocks mentioned as well as deep correction in retail, travel and emerging market sectors in general.



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