In our view, the recent sharp market rotation that we have seen – from “low volatility growth” to “high volatility value” – is a continuation and acceleration of the trend change that has been underway since the third quarter of this year. The turning point for “quality growth” and other hideouts was marked by the Brexit vote. We believe that we are moving, globally, from a growth to a value market. This is a major call, since it has been wrong, since the financial crisis, to favour value.
Trump was not the ideal candidate in most people’s eyes and his presidency brings a lot of uncertainty, not least the debt ceiling debate, the prospect of protectionism, a repeal (or partial) of Obamacare and his ‘America first’ views on foreign policy. However, his ‘policies’ seem expansionary, with likely tax cuts and a significant infrastructure bill. This has significantly changed inflation expectations not just in the US, but around the world.
The sheer speed and magnitude of the post-election rotation underscores just how crowded low volatility stocks and the deflation trade had become. It has long struck us as wrong to pay north of 20 times earnings for stocks generating 3% growth. This only made sense if the world was entering recession and/or deflation. In other words bonds and their proxies were already priced for such. This is why many European “growth” strategies have been badly hit.
Having already tilted our strategies to value we accelerated this in October and the portfolios responded well to the election result. We would never play for a 24 hour or 48 hour move and see these events as underlining the move to a normalising yield curve – a move that was already underway. The most important move was our increase in banks. These have performed well since the election and we intend to continue to hold them. We made a tactical increase in healthcare holdings Novartis and Roche ahead of the election, and will review the positions. We had significantly reduced our exposure to consumer staples and other low volatility names, such as Henkel and RELX, and this has also paid off. We do not anticipate major changes in the short term.
Markets will now move on to the next “domino” in this political sequence: the Italian referendum (not forgetting forthcoming elections in Austria, Netherlands, France and Germany).This will most likely mean that volatility will remain high. It is also a risk to our financials exposure and we may need to be tactical around this. It is our view that the low is in for bond yields and that investor positioning remains too much in favour of low volatility “safety” and underweight hard-to-like European banks. Our biggest concern is that markets go after the European project and the whole existence of the European Union and the euro is once again questioned. In the meantime markets look well bid and the Eurostoxx (a value proxy) should be watched as it tries once again to break out to the upside.
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