Is it Time for a Full-Fledged Rotation?

by | November 16, 2020

In a week ending with ‘Friday the 13th’, investors were not spooked, and continued to bid up prices of global risk assets. Market participants took heart from the US election outcome and declining odds that the result will be effectively contested by President Trump. Surprisingly, investors also looked past worrying record rates of US Covid-19 infections and hospitalizations, accompanied by a climbing death toll.

Recent global equity market performance has shifted. Rotation into energy, small capitalization, value and cyclical stocks was plainly evident last week. Erstwhile stalwarts, such as growth, information technology or momentum stocks are beginning to lag. This would be a big deal if it continues because value has underperformed growth for more than a decade.

So, does recent market performance herald the start of a full-fledged rotation from growth to value stocks?

Our take is, yes, value and cyclicals will lead markets higher. But with an important caveat – not yet.

It is likely that fans of rotation will get a boost this coming week as various Fed and ECB speakers provide reassurance that monetary policies will remain highly accommodative and flexible. However, it should be expected that US retail sales and industrial production will depict a mixed picture about the health of consumers and producers. And incoming economic indicators will be viewed as backward-looking, given the backdrop of rising pandemic risk as colder weather envelopes the northern hemisphere.

Importantly, the coming few weeks also hold out the promise that other biotech and pharma companies will release encouraging vaccination test results, backing up last week’s promising trial studies from Pfizer and BioNTech.

In short, the near-term economic, public policy and pandemic news flow is likely to be uneven, producing fits and starts in global markets. This won’t enable a sustainable rotation into riskier stocks – for that to happen, investors require an uninterrupted period of positive developments.

History also suggests that rotation into value and cyclical shares necessitates more than just attractive absolute or relative valuations. The crucial factor is earnings acceleration. Value and cyclicals only tend to sustain outperformance when their relative earnings growth picks up compared to that of the broader market.

In that regard, concerns about tighter social distancing regulations in the coming months are likely to raise doubts about the ability of financials or industrials to boost profits soon. Pandemic control remains critical to durable economic and earnings recoveries.

Dividend yielding stocks – often found in the value universe – may also struggle to regain favor among investors, given uncertainties about sustainable payouts. The energy sector, which was last week’s top performer, will come under greater scrutiny due to the Biden Administration’s carbon emission reduction priorities.

Concerns about growth and demand in the US and Western Europe will act as a brake on the fortunes of more cyclical emerging economies, including those heavily reliant on commodities and basic materials. For now, countries in North Asia, including China, South Korea and Taiwan appear better positioned to weather pandemic-related jitters in global capital markets.

Still, the picture is brightening for more cyclically sensitive sectors and styles. Modest US fiscal stimulus, arguably postponed until early 2021, implies an even more accommodative Fed stance. The result is likely to be a weaker US dollar, which typically supports raw materials prices and emerging markets. Despite surging infection rates, state and local governments have learned from experience that social distancing, mask mandates and increased testing are preferable to full-scale lockdowns. Firms are able to cope with remote and flexible work routines. Accordingly, the economic and earnings hits related to pandemic control should be less onerous than earlier this year. And critically, the prospects for the successful rollout of a vaccine next year will provide key support to markets. 

Overall, the conclusion is that while sector rotation is arriving, patience is warranted.

Market performance will probably be uneven and inconclusive over the remainder of 2020. Investors will be reluctant to shun what has been working – e.g. large capitalization information technology stocks –  so long as infections are rising at high levels. For now, it might be wise to barbell growth and quality with value and cyclicals, shunning momentum (which will struggle as markets oscillate). Furthermore, US dollar weakness is an opportunity in its own right and will also support emerging equities and currencies. 

Rotation in markets is the next big opportunity. Value has a lot of room to make up for a decade of underperformance. But sometimes it pays to be patient. Now is one of those times.

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets.

Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy.

Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland.

From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT.

At both GAM Investments and UBS Investment Bank Larry was widely recognised for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others.

Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides commentary and analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved.

Friedman is a senior business leader with two decades of experience growing and transforming businesses in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank.

Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard.

Friedman served as a White House Fellow in the Clinton administration and as an assistant to the Secretary of Defense. He is a member of the Council on Foreign Relations and the Chairman of the Advisory Board of Project Syndicate, the non-profit opinion page that provides world-class commentary to over 500 newspapers globally. In addition, he is a board member of the American Alpine Club and the Jackson Hole Community Housing Trust, and has served on the boards of the Gates-Cambridge Trust, the Seattle Art Museum, and a number of other non-profits. 

Friedman is a regular contributor to several newspapers and thought leadership groups and has published numerous opinion editorials on topics including economics, finance, philanthropy, and politics in Project Syndicate, Bloomberg, The Wall Street Journal, The Financial Times, The Guardian, CNBC, The South China Morning Post, The Chronicle of Philanthropy, and other news outlets. He is also the author of Babu’s Bindi, and The Big Thing, both children’s book.

An avid mountaineer and rock climber for 30 years, Friedman has climbed some of the world’s highest mountains and led the first major climb to raise money for charity through an ascent of Mt. McKinley.

He holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

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