The Dow has missed Wall Street's massive rally, a clear sign that value stocks are the way to play the economic recovery.
Over the past few weeks, the stock market has pulled off an impressive recovery despite gloomy economic predictions. But while the Nasdaq has managed to rise 1.1% over the past three months, the Dow Jones Industrial Average is down nearly 13%.
Some say the disparity underscores how antiquated the Dow has become; viewed from another angle, it offers investors some sage investment advice.
A big reason why the Dow isn’t recovering at the same rate as other indexes is that it doesn’t include the FANGs.
The way the Dow is weighted means mega-caps like Amazon (NASDAQ:AMZN) can’t be included. That underscores the fact that only a handful of stocks are propping up this stock market rally. More importantly, it highlights the parts of the U.S. economy that can’t thrive in a world stuck with social distancing.
If pandemics, social distancing, and lockdowns are the future, then the Dow is indeed an antiquated index. But if you believe the economy will eventually return to “normal,” the Dow is where you want to look for investment ideas.
Facebook (NASDAQ:FB), Alphabet (NASDAQ:GOOGL), Amazon, and Netflix (NASDAQ:NFLX) are all stocks that will thrive in a world that lacks social contact. Meanwhile, some of the Dow’s stalwarts like Boeing (NYSE:BA) stand to perish if people don’t eventually start traveling again. A bet against the market is a bet on a return to normal.
That brings to mind the prospect of value investing–something investors have all but abandoned in this momentum-fueled rally. Value investing is something Warren Buffett popularized, and value investors seek out undervalued companies that stand to gain in the future.
SEI Investments’ James Solloway says they’re about to come back in fashion:
There are periods where leadership changes in a drastic and dramatic fashion and they usually correspond with the bottoms, or the near-bottoms, of a recession following a period of accelerated deterioration in those asset classes. And that is precisely what we have seen this year with small caps, value stocks, and emerging markets
Salloway believes that a potential second virus outbreak will be met with resilience this time as most countries are better prepared to deal with the influx of new patients. With that in mind, he thinks it’s time to start looking to underappreciated sectors rather than stay-at-home stocks:
I do believe that when all is said and done, we are not going to have as bad a second reaction to another wave as the first one, and if that’s the case, then I think that provides the fundamental rationale for investors to seek out the most bombed-out sectors of the stock market as they usually do.
So, where’s the value in today’s market? There are a ton of places to look both inside and outside the Dow Jones. But the pros say the best value stocks to buy are those that have encountered temporary stumbling blocks that will improve as the economy reopens.
Warren Buffett’s investment firm Berkshire Hathaway (NYSE: BRK) is one such underappreciated equity. Fund manager Bruce Berkowitz has been buying up thousands of shares throughout the first quarter, and famed investor Bill Ackman also scooped up shares in recent weeks.
Other value plays worth a look, according to Mark Hulbert’s Hulbert Financial Digest, include Walt Disney (NYSE:DIS), FedEx (NYSE:FDX), and International Business Machines (NYSE: IBM).
Investors with a stronger stomach might want to look into the beaten-down airline sector to pick up strong players like Southwest (NYSE:LUV).