A few weeks back, as an eventful first quarter melted into what’s expected to be a blockbuster stretch for US growth in Q2, I suggested that “the big question” is still whether, and to what extent, the equity rotation, in all its various manifestations, will continue to run.
Most believe something like an economic renaissance is a foregone conclusion thanks to mass vaccination and a grand re-opening of the US services sector. I should mention that there will be speed bumps. And they may be tragic. One of the half-dozen women cited in federal officials’ decision to halt J&J COVID vaccinations in the US is dead, for example. (That comes with the usual disclaimer: I’m not a doctor. I can’t say, definitively, whether her condition was or wasn’t related to the J&J shot. All I can do is document events as they happen.)
But even if things continue to go largely according to plan, it’s possible that quite a bit is already in the price. On Monday, Nomura’s Charlie McElligott said that as the market transitions from the “Recovery” phase to the “Expansion” phase, economically-sensitive names and other expressions associated with reflation and cyclicality could cool off, not necessarily because there’s anything “wrong” with the macro thesis, but rather because markets pull forward future outcomes and the “easy money” may already have been made. That could help tech and other perennial winners-turned laggards recover some ground lost in the post-election, pro-cyclical bonanza.
Recent outperformance from big-cap tech perhaps offered a preview, and it’s consistent with some of the nuance found in the April vintage of BofA’s Global Fund Manager survey, which showed “a modest rotation to tech.” “Investors have now reverted back to the barbell of tech and cyclicals, but have modestly trimmed EM and commodities,” the bank’s Michael Hartnett said Tuesday.
And yet, even as the survey showed waning conviction in the notion that small-caps will continue to outperform, the net percentage was still historically very high, suggesting enthusiasm around one of the most dramatic manifestations of the rotation (i.e., small over large) remained elevated in April.
Perhaps more importantly, the survey showed that investors’ perceptions of the value rotation are intact. Indeed, at 53%, the net percentage of respondents who believe value will outperform sat at a record (figure below).
Over the years, I’ve described every value rotation as “nascent” or “burgeoning.” In fact, I’ve used those descriptions so often to discuss rotations that I began penning articles documenting how I turned those descriptors into a cliché.
But, this time it might be for real. It could be that the pandemic brought forward the final, parabolic leg of growth outperformance, and that the market is now ready to try something different (as it were) amid a heightened fiscal impulse and expectations for a post-viral apocalypse economic boom. The red-shaded area in the figure (below) shows value outperforming. The large red bar marks the week Pfizer unveiled results from its vaccine study. The green-shaded area shows the above-mentioned comeback for growth over the first few weeks of the new quarter.
If you ask JPMorgan’s Marko Kolanovic, a sea change may be afoot.
“We might be at a more significant turning point rather than just historically what were blips that reverted back to the growth investing style,” he told Bloomberg, in an interview. “We think this recovery can last longer and be more profound and have more of an impact on investor styles and flows than people appreciate.”
For Kolanovic, 10-year yields in the US would probably need to make it all the way up to around 2.50% before it became problematic for stocks, and besides, the backup in yields is part and parcel of the outperformance thesis for value and other themes and styles that lagged during the long-running “slow-flation” macro regime.
In the BofA survey, the bank’s Hartnett noted that “nobody believed rates at 1.5% would cause an equity correction but the move from 1.5% to 2% is critical as 47% of investors now think 2% is the level of reckoning in the 10-year Treasury that will cause a 10% correction in stocks.”
Of course, those survey respondents would almost invariably change their answers if Treasury yields were to rise to, say, 2.25% and stocks kept pushing higher anyway.
The “average level of reckoning” rose to 2.10% this month from 2% last month, Hartnett remarked.
I think I needed to hear this. Thank you. Both sides of the argument have been phrased. It will be messy for sometime. Well, messier. J&J on hold, pockets of Covid uptick, weird inflation numbers.
I still think a lot depends on your time horizon. Sure, 2021 might pan out well for cyclicals. But longer term? This economy is being driven by tech, both directly and indirectly.
Sure, all growth prospects could have been priced in (and then some) so I could be right on the macro level and wrong on the stock picking level. I’m betting a big part of my career I’m not.
Between the immediate/obvious recovery stories (airlines, hotels, etc) and the secular growth names (tech, mostly), I think there will be an intermediate phase.
If the US and global economy has a year of strong growth in 2021/2022, corporate profit growth will not be “scarce” and investors will be less compelled to pay very high valuations for secular growth/tech in the face of rising yields.
During the intermediate phase, I think the stocks that will do best will include many that are relatively less known. Some may look a little value-y, others will look kind of cyclical, but many will be high quality “growth at a reasonable price” (GARP) names, and many will be small and mid cap.
Then we’ll get back into the environment in which secular growth shines. At that point, perhaps a year or more from now, many of those names will look more reasonably valued, either due to growth or price change.
This is a US-centric comment. Looking overseas is also very interesting at this time.
What else did Kolanovic say?