Among the many crises that have kept Americans awake at night in 2020, one that looms large is the idea of a “K-shaped recovery” from COVID-19. That’s the premise, backed by a growing body of evidence, that a year of lockdowns, isolation, and uncertainty have widened the wealth gap between America’s work-from-home managerial classes and its paycheck-to-paycheck frontline workers—with the two groups’ well-being moving in opposite directions like the arms of a “K.”
The stock market, meanwhile, has undergone its own K-shaped recovery, albeit one with less dire consequences. Borne up by events that made us more dependent than ever on technology, from e-commerce to teleconferencing, the five Big Tech stocks lumped under the awkward acronym FAAMG—Facebook, Apple, Amazon, Microsoft, and Google—have returned 52.5% year to date, compared with just 6.3% for the other 495 members of the S&P 500. Together, they now have a market cap of $7.2 trillion. If you were keeping your entire portfolio in a typical, “cap-weighted” S&P 500 ETF, 23% of your assets would now be parked in those five stocks alone.
The weeks before Thanksgiving brought promising news on two COVID vaccines, with more likely to come. Though a very difficult winter looms, the odds are good that these lifesavers will help the global economy turn the corner on the pandemic in 2021—and, with luck, trigger a recovery that’s strong enough, and broad enough, to KO both those K-shapes.
Where stocks are concerned, that ray of hope is leading pros to reconsider where they’ll earn the best returns. In the industries most beaten down by the pandemic, the thinking goes, companies’ shares should have more room to snap upward as their earnings recover. “It’s the materials stocks, the consumer discretionary, the financials, industrials that will come roaring out” as the economy normalizes, says Sarah Ketterer, CEO of Causeway Capital. Many managers believe that non-U.S. stocks, which sank faster than U.S. equities as the pandemic settled in, are also poised to surge. Whatever happens, FAAMG won’t be the only game in town, says Saira Malik, head of global equities at Nuveen: “I don’t think we’re going to end 2021 saying, ‘Five growth stocks were all you had to own.’ ”
Betting on these sectors doesn’t mean bailing out of tech stocks. Technology’s central role in driving economic growth is undeniable. That said, analysts expect tech earnings to rise at a slower rate than earnings for the S&P 500 as a whole in 2021. That’s another sign that stocks in other industries could enjoy a prolonged spell in the sunshine as the global economy gets healthier. With that in mind, we sought out stocks in six categories that are poised to deliver big results as the world rebuilds.
Energy and infrastructure
As the U.S. builds new economic backbones, these stocks will benefit.
A new administration typically raises investor hopes of fresh spending on infrastructure—upgrades that both sides of the aisle tend to support. President-elect Joe Biden campaigned on two particularly timely infrastructure themes: a climate plan that calls for $2 trillion in federal investment in “sustainable infrastructure,” and a $20 billion proposal to invest in rural broadband connectivity. Yet even if funding stalls in a gridlocked Congress, there’s reason to bet on companies that build these backbones of the future economy.
Many investors are setting their sights on renewable sources of electricity. While wind and solar account for only about 7% of world electricity generation today, the International Energy Agency expects that figure could rise to 40% by 2040. “We’re just in the very early stages of a multi-decade growth opportunity within renewables,” says Josh Duitz, a senior portfolio manager helping to oversee the Aberdeen Standard Global Infrastructure Income Fund. He’s a fan of utilities known as “yieldcos” for their high dividends, including U.K.-based Atlantica Sustainable Infrastructure (with a 5% dividend) and Clearway Energy (yielding 4.6%), which own and operate solar-panel installations and wind turbines across the U.S. and abroad. Duitz also likes NextEra Energy, the biggest renewable-energy utility in the U.S. NextEra plans to invest $1 billion next year in the emerging frontier of battery storage. That innovation is key to taking renewable energy mainstream, enabling it to be used even after the sun sets or the wind dies down.
The Footprints of Five Giants…
Facebook, Apple, Amazon, Microsoft, and Google (the so-called FAAMG stocks) now account for almost a quarter of the value of the S&P 500.
Mobile data consumption was already growing more than 30% a year in the U.S. before the pandemic; with the reliance on teleconferencing for work and for school, we’re using even more. That means telecom companies will need to continue fleshing out their 5G networks for years to come—in part by putting more antennae on cell towers. “The physics of it is, the more bandwidth you require, the shorter the distance you need to be to a tower,” explains Nick Langley, senior portfolio manager at ClearBridge Investments. That’s good news for real estate investment trusts like Crown Castle and American Tower, which Langley expects will grow earnings at a high single-digit rate for as much as a decade. Duitz recommends Spain’s Cellnex, which is also growing through acquisitions as more European cell phone companies shed their towers to pure-play operators.
Atlantica Sustainable Infrastructure (AY)
Clearway Energy (CWEN)
NextEra Energy (NEE)
Crown Castle (CCI)
American Tower (AMT)
Cellnex (CLNX)
Health care stocks
Waiting for COVID to release its grip on the health care system.
The pandemic is a health care crisis that has been brutal on some health care companies. Elective procedures, a big profit-generator for device makers and hospitals, slowed or stopped altogether, while older people in particular put off medical care of all kinds to avoid exposure to the coronavirus. But while COVID-related challenges remain, encouraging progress on potential vaccines has led some investors to double down on companies that will benefit from a return to normal.
Eric Schoenstein, a managing director and portfolio manager at Jensen Investment Management, likes Stryker, a top producer of orthopedic implants, joint replacements, and other technology that caters to the needs of an aging population. Stryker has what Schoenstein calls a “first-mover advantage” with its robotics-assisted surgical platform, which is used in hip and knee replacements. Roughly half of Stryker’s business can be categorized as “elective procedures,” but as those procedures continue to come back, analyst estimates project its revenues growing more than 13% in 2021. The stock, meanwhile, trades at valuations slightly below the sector average.
Made Bigger by a Boom Year
As the pandemic increased our dependence on telework, e-commerce, and home entertainment, the FAAMG stocks soared.
The full-fledged return of elective surgeries will also benefit Teleflex, whose products include many used in vascular and urology procedures and the treatment of prostate disease. Lori Keith, who manages the Parnassus Mid Cap Fund, sees long-term demand for Teleflex’s equipment as baby boomers age. The stock isn’t cheap, at nearly 30 times estimated forward earnings, but analysts think Teleflex could grow revenues by 13.5% in 2021.
Giant insurer UnitedHealth Group has navigated the pandemic well; its profits even rose early on owing to the decline in elective procedures, leading it to pay some rebates to customers. But Saira Malik of Nuveen calls the absence of post-election risks the “biggest positive” for the insurer: With the next Congress expected to be evenly and sharply divided, Medicare for All is not to be. Malik expects UnitedHealth to expand its footprint in Medicare Advantage plans “at the fastest rate in five years” and to increase memberships in its Optum business (which includes health savings accounts and payment processing). The stock’s forward P/E, at 22 times estimated earnings, trails the S&P 500 average, and Malik believes UnitedHealth could close that gap “as the company’s business model returns to normal” and its shares climb.
Stryker (SYK)
Teleflex (TFX)
UnitedHealth Group (UNH)
Consumer stocks
There’s life after lockdown for some retailers and for live events.
Retail’s long shift to e-commerce accelerated even faster as the pandemic shuttered stores nationwide. But if the eventual arrival of a vaccine coaxes still more people back into in-person shopping, companies that rely on physical stores could reward investors nicely. That’s particularly true of discount retailers, which have been able to please customers with a “treasure-hunting” experience along with lower prices that are welcome in a shaky economy. Parnassus’s Keith is a fan of Burlington Stores, the third-largest off-price retailer in the country after Ross Stores and TJX. Burlington was hit less hard than some brick-and-mortar retailers because many of its stores are in stand-alone locations, not malls, and were able to reopen early. And new CEO Michael O’Sullivan, who came to the company in 2019 from Ross, is making investments in tech for supply-chain management and analytics that should help Burlington continue to improve its operating margins.
An era in which people prefer outside to inside could be a boon for apparel titan VF, whose portfolio includes outdoorsy brands like Vans, The North Face, and Timberland. Investments in e-commerce have paid off with sales increases in recent quarters, Keith says, and the company has shed older brands like Nautica and Reef in recent years to streamline its offerings. Keith also believes VF’s recent $2.1 billion acquisition of youth-favorite streetwear brand Supreme is a potential accelerant for the company’s growth.
Making Up for Lost Time
Analysts expect hefty profit growth almost across the board in 2021, as the economy gets back up to speed.
Katie Koch, cohead of fundamental equity at Goldman Sachs Asset Management, believes that among younger consumers, experiences like concerts and travel matter more than retail therapy—and once a vaccine arrives, businesses that specialize in such experiences could boom because of pent-up demand. That would be music to the ears of Live Nation, the concert and event behemoth that owns the likes of Ticketmaster. Live Nation’s revenues are down nearly 60% in the past 12 months, and with no clarity on when live events might get the all-clear, Wall Street expects earnings to stay depressed in 2021. But Koch says the company has the “balance sheet strength to make it through a continued, protracted shutdown.” For events canceled because of the pandemic, over 80% of Live Nation’s customers opted to hold on to their tickets instead of getting a refund. To Koch, “that’s just a great data point that people are committed.”
Burlington Stores (BURL)
VF Corp. (VFC)
Live Nation (LYV)
Bank stocks
The pandemic chased investors away, but profits have stayed steady for many of the “Big Four.”
No group of companies is a better proxy for the health of the economy than the four giants of financial services: JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup. So far, the market’s comeback has mainly bypassed the Big Four. Since Jan. 1, while the S&P has risen 10%, they have lost an average of 22%. But that has left their stocks so cheap that if their profits rebound, investors could pocket substantial returns.
Several factors are trending in banks’ favor. A strengthening economy should gradually lift rates, boosting “net interest income”—the spread between what banks charge on home and credit card loans and what they pay in interest on deposits. And the Big Four have been posting steady earnings even after taking charges for pandemic-struck loans. Owing in part to a new accounting rule, from January to September, the Big Four booked $62 billion in provisions for bad credit, covering all the COVID-induced losses they’re expecting. The good news: “Unless the U.S. goes into another steep recession, losses should remain at much reduced levels,” says Charles Peabody, chief of boutique research firm Portales Partners.
Underfunded
Bank stocks have lagged the broader market, but bank earnings should jump as the economy moves closer to normalcy.
Bank of America is particularly likely to gain from a rising economy, because it’s focused more on the consumer than on investment banking or trading. In the third quarter, falling rates cut BofA’s net interest income by $2.1 billion, or 17%—but the bank still posted $4.9 billion in profit. It reckons that every one-point rise in the 10-year Treasury yield swells its pretax earnings by $3.34 billion. Peabody thinks BofA’s consumer-heavy mix is super-well positioned for the recovery. “This rebound is more about Main Street than Wall Street,” he says, driven by demand for credit cards and mortgages. And at a P/E of just under 8 on 2019 profits, BofA is cheaper than JPMorgan.
Wells Fargo is a chancier bet. The bank has been suffering from costs associated with a regulatory crackdown over its unethical sales practices, and the Fed has imposed strict limits on its growth. Wells’ shares have fallen 60% from their 2018 peak. But CEO Charles Scharf has had success in chopping expenses. And like BofA, Wells is mostly a consumer franchise—it wrote the most mortgages last year among the Big Four. That fact should help it benefit greatly from rising rates.
Bank of America (BAC)
Wells Fargo (WFC)
Airlines and aerospace
Wary passengers and grounded flights won’t stop these stocks from climbing.
Promising vaccine data in November sent airline stocks soaring off their lows, but investors caution that shares may struggle to ascend much higher anytime soon. Though business travelers vaccinated against COVID-19 may be more comfortable flying, they may still be less inclined to fly to work meetings when they could Zoom instead. And planes aren’t profitable to fly unless they’re full.
Instead, investors hoping to reap returns from a recovery in air travel are looking further up the supply chain, at companies that make and repair airplane components. “There’s lots of ways that airlines can save money, but plane maintenance is not really one of them,” says Bill Callahan, investment strategist at Schroders. As long as planes are taking off, their parts are wearing out—and fixing them is a lot cheaper than buying a brand-new aircraft, which airlines can’t afford at the moment. “Boeing’s pain is their gain,” Callahan says of manufacturers like Cleveland-based TransDigm, which makes aircraft components from the cockpit to the lavatories, and Hexcel, based in Stamford, Conn., which specializes in carbon fiber for planes. While both companies’ shares have surged recently, they’re still far from their pre-pandemic highs; Hexcel trades nearly 40% below its 2019 peak.
Holding Pattern
A partial recovery in U.S. air travel in the summer and fall leveled off as coronavirus cases surged again.
For those who are willing to bet early on airline stocks, consider those with businesses focused on the U.S.: “International travel is going to be impacted for longer than domestic travel,” notes Callahan. Domestic-focused Southwest Airlines has ridden out the crisis more smoothly than the other major U.S. carriers and has taken advantage of pandemic-induced travel slack to add 10 new airports to its routes by mid-2021. Peter Essele, head of portfolio management for Commonwealth Financial Network, believes JetBlue’s reputation for superior customer experience will give it an edge in the long term over more traditional carriers, well beyond the pandemic. Buyer beware, however: Even the strongest airlines will face a lot of turbulence next year.
TransDigm (TDG)
Hexcel (HXL)
Southwest Airlines (LUV)
JetBlue (JBLU)
International stocks
Investors looking abroad are finding strong companies at bargain prices.
During the COVID crisis, American stocks have traded at a premium to international stocks because they were, well, American: Their businesses were supported by stimulus spending from the Fed and by the dollar’s status as the global reserve currency. When the pandemic finally eases, says Goldman’s Koch, “I don’t think the U.S. will have the same hegemony of market outperformance” as investors grow more confident in non-U.S. names. Another confidence-booster for Asian and European stocks: A Biden administration will be more predictable than its predecessor on trade issues.
One stock that Nuveen’s Malik believes will continue its upward trajectory is Taiwan Semiconductor Manufacturing Co. (TSMC), the world’s largest contract chipmaker. The company makes chips that are central to the buildout of 5G worldwide. And semiconductor titan Intel’s recent manufacturing woes are “certainly going to indirectly, if not directly, benefit TSMC,” Malik argues, as Intel may subcontract more of its own chips to TSMC. But the stock still comes at a reasonable price tag, trading at around 23 times forward earnings.
Jensen’s Schoenstein favors Unilever, the multinational beauty and food giant that’s currently consolidating its headquarters in London. Unilever’s brands, which include Dove soap, Lipton tea, Breyers ice cream, and Vaseline, are sold in 190 countries, and its China and North America businesses have been recent bright spots. Like other consumer goods behemoths, Unilever held up well as shoppers filled their pantries during the pandemic. If consumers stay loyal, its stock could have room to run, since it trades at a modest 21 times forward earnings, compared with the U.S. consumer staples average of nearly 26.
Some of those Unilever products may well reach customers via Canadian National Railway, a freight-only railroad whose lines run through the U.S. and Canada and link major ports on the Atlantic, the Pacific, and the Gulf of Mexico. CNR transports a diversified mix of oil, metals, minerals, and forest products, and its consumer goods shipping business saw a particularly sharp recovery as the COVID crisis played out. CNR continued making improvements to its rail network during the pandemic. Schoenstein says that efficiencies from those investments, plus relatively low fuel prices, should position CNR to do even better once other economic locomotives start gaining speed again.
Taiwan Semiconductor Manufacturing Co. (TSM)
Unilever (UL)
Canadian National Railway (CNI)
How Fortune did: When it pays to be cautious
While no one could have predicted the insanity of 2020, Fortune writers Rey Mashayekhi and Anne Sraders did anticipate a year of iffy growth and political tension. The 27 stocks and ETFs they picked in “The Yellow-Light Portfolio” put an emphasis on prudent, resilient companies—and it beat the S&P 500 over the ensuing year, with median returns of 20.6%, including dividends, to the market’s 19.5%. Here are some highlights.
Electrified
Whatever you think of Elon Musk, there’s no denying Tesla had a torrid 2020. The electric-vehicle maker ironed out its production kinks, fought its way to profitability, and earned a spot in the S&P 500. The stock has returned 505% since we picked it, making it by far our best performer. Another winning pick in a related field: Nidec (up 51%), a Japanese maker of EV motors.
Safe shopping
The pandemic has put retailers under tremendous strain but rewarded those that adapted nimbly. Target staffed up to keep its stores open and clean, and stole market share from rivals; it has returned 53% since last year. The work-from-home trend, meanwhile, boosted Home Depot, as homeowners renovated, repaired, and traded up to make the best of their round-the-clock domestic surroundings.
Cash our chips
Our tech picks included Alphabet and Microsoft, which had great years. But our top tech performers were little-known chip specialists. Shares in Synopsys, whose software is used by semiconductor-design wizards, and Dutch chip-component maker ASML returned 63% and 61%, respectively. Each stock soared (along with their industry) as global demand for digital hardware increased.
Can’t win ’em all
Our portfolio included five “bold bet” picks, companies with higher-risk profiles. Tesla and Nidec paid off. British retailer Burberry (down 19%) did not, as luxury brands got crushed by COVID. The fallout from past scandals, meanwhile, clobbered Wells Fargo (down 52%), though our team is betting this year that better times are coming for the battered bank.
A version of this article appears in the December 2020/January 2021 issue of Fortune with the headline, “Stocks for 2021: Invest in the big rebuild.”
