Be wary of the market leadership rotation

Investors, tired of the current hot button issues, have shifted their focus to a potential regime change. But they may be jumping the gun

Sep 13, 2019 | Krishna Memani

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 have ended

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.

Krishna Memani serves as the Vice Chairman of Investments for Invesco.

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