There’s been no shortage of chatter this year about a historic disconnect between value/cyclical stocks and low volatility/defensive names.
JPMorgan’s Marko Kolanovic described it as a “record divergence” last month, noting that it’s “much more significant even when compared to the dot com bubble valuations of the late ’90s”.
To illustrate, he pointed to a rather astonishing valuation disparity using forward P/Es between value and low vol. stocks .
(JPMorgan)
“While there is a secular trend of value becoming cheaper and low volatility stocks becoming more expensive due to secular decline in yields, the nearly vertical move the last few months is not sustainable”, Kolanovic wrote, in a July 16 note, adding that better economic data and signs of progress on the trade front could help catalyze a convergence.
With that in mind, SocGen’s Andrew Lapthorne is out with a new note that highlights the “polarization” within equity markets. “We have a cyclical bear market within an equity bull market like we saw in 1999/2000”, he writes, highlighting the following chart which shows a widening disparity between bond proxies and cyclicals.
(SocGen)
Obviously, that’s consistent with the current market zeitgeist, defined as it is by persistent growth jitters and the concurrent plunge in bond yields.
Irrespective of the “how?”, “when?” and “why?” around an assumed convergence trade, a more immediate question is whether folks are making a mistake by overpaying for bond proxies.
For his part, Lapthorne thinks that’s a distinct possibility. “Investors are paying twice the price for bond proxies than the more economically exposed cyclical assets”, he said Thursday, before suggesting that the assumption of immunity from cycle risk is misplaced.
“‘Bond proxy’ profits fell 30-40% in the GFC”, he reminds you. “Not the 60%+ decline seen in cyclicals profits, but quite a big decline nonetheless”.
