As investors came back from the summer break, they seemed to
be done with talking about trade, the Fed, and the next recession.
They are now more interested in considering a regime change.
I am, of course, talking about the great market rotation that is taking place.
Rotation, as you can imagine, means different things to
different people at various times. In the current context, however, this
conversation is really about market leadership moving away from the hegemony of
lower interest rates and tech-oriented growth.
Too soon for value
investors to celebrate?
Value investors are obviously rejoicing. They have not had a
good day in a while and now, all of a sudden, everything seems possible.
While it’s good to enjoy a few days of good fortune, they shouldn’t
rejoice too much. I believe this market rotation will prove to be as ephemeral
as similar moves since the end of the financial crisis were.
I’m not suggesting there can’t be a modest change in the
relative performance of certain factors and strategies, given that the
performance of some sectors, like defensives and technology, has been
excessive. But, in my view, regime change it ain’t.
Big moves in rates
The massive move in interest rates is certainly over. Cautious
investors piled into interest rate-sensitive sectors that benefited from lower
rates. This, in turn, brought in momentum investors chasing those
hot-performing sectors. Today, cautious investors may be reevaluating what now,
to use a soccer metaphor, seem like offside positions. The outperformance of
those interest rate-sensitive sectors was most likely a short-term market
adjustment. Again, regime change it ain’t.
As rates rise—I expect the yield on 10-year US Treasuries to
be around 2% by year-end—the move out of defensives and into cyclicals can
continue for a bit but will eventually fade.
For this current move to be a true market regime change, I
believe two things must happen:
1) interest rates have to move meaningfully higher on a global basis, and
2) global growth expectations have to increase significantly, as well.
I don’t believe either of these outcomes are very likely.
Without these fundamental changes, investors may most likely
continue to look for safety on one hand and on the other, pay high prices for equities
that can deliver growth or credits that offer higher yields.
While the Fed will certainly cut rates, the European Central
Bank (ECB) has unveiled its own accommodative easing and monetary stimulus
package. China will continue to work on preventing its economy from slowing
down catastrophically. The best we can hope for in the current environment is
for global growth to stabilize rather than increase meaningfully.
With global trade in the dumps, capital investment slowing
globally, and overall disinflationary expectations persisting for the
foreseeable future, I can’t come up with a single scenario in which the outlook
for global growth improves a great deal.
If there is going to be a change in this somber outlook, the
change will first manifest itself in emerging markets (EM), as the growth
outlook is not as structurally burdened there as it is in the developed
markets. But there is no indication whatsoever that the EM growth outlook is
changing. Stabilization? Sure. Significantly better growth? Not very likely. The
weakness in global trade certainly has been a burden for most of EM. Even for a
domestically driven economy like India, which isn’t as dependent on trade, the
growth outlook is not so hot.
The bottom line from my perspective remains the same – rates
will remain low and, while policy is supportive, global growth will, at best,
stabilize. Be wary of the market rotation talk and don’t let the talk of
rotation or regime change sway you into making meaningful changes in your
portfolio. Absolute and relative valuation, at least for now, ought to drive
HOW MUCH risk you take rather than WHAT risk you take. In my view, tech and
other high-growth sectors in equities and credit in fixed income remain the asset
classes of choice.
Blog header image: ChutterSnap / UnSplash
The opinions expressed
are those of the author as of September 4, 2019, are based on current market
conditions and are subject to change without notice. These opinions may differ
from those of other Invesco investment professionals.
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