Here’s a paradox. What happens when two ‘consensus’ views completely butt up against each other. On the one hand, I think if we were to ask most investors, they’d probably say the current rally is the most hated rally in decades. Everyone is perfectly happy to play along but everyone is also quietly mumbling that these prices are ‘bonkers’.
Set against this, nearly every major orifice of investment wisdom – institutional wisdom that is – is mildly optimistic, if not out and out bullish for equities. And these institutions are not alone. Many private investors are aggressively bullish as well. So which consensus is right – is this rally really that unloved or is it really well-founded? I suppose the trite answer is to suggest cognitive dissonance i.e that two contrasting views can both be right at the same time. That certainly seems to describe many Trump supporters who say they are keen on defending the constitution even if it means ignoring the said constitution.
Anyway, cheap political point out of the way, as we start the new year I thought it useful to take stock of where we are. Here are three fairly consensus institutional views, all supportive of a continuing risk rally.
Let’s start with Deutsche Bank. They argue in their latest Investor Positioning note that “Global growth prospects suggest equity inflows have further to go. The pace of equity inflows has historically been closely tied to global growth (PMIs). While recent inflows have been running slightly ahead, if global growth picks up in line with DB’s house view, there is significant room for inflows to rise.”
The nice chart below sums up this view very well.
Cross asset class analysts at SocGen, the big French investment bank, are also broadly supportive of risky equity assets although there are a few obvious strategists at said bank who probably hold a diametrically opposite view.
In SGs latest Conviction Thinking report the main cross-asset team sum up their view as follows: “All in all, with a policy background still heavily geared towards calming financial risks (i.e. active monetary policies), supporting the real economy and distorting the credit cycle (think fiscal policy and state interventionism), we see little reason to change our (reasonably) optimistic view on risk assets; liquidity support for the credit market and accelerating M&A should help peg equities higher up the scale. Our updated equity risk premia indicators (chart 5 US, 6 Japan) still show equities heavily discounted versus the rates environment, with little prospect of monetary policy tapering any time soon in the Western world.”
The second chart below nicely sums up the view that the current rally is far from entering exuberant territory.
Last up are the Cross Asset specialists at Morgan Stanley, who – in a note from earlier in December of last year – declared that “while cheap valuations have generally boosted nominal expected returns, most of this boost has been offset by low inflation expectations and a low-income component versus history. However, given how much government bond yields and expected returns have fallen over the past year, equity risk premiums now look fair to attractive across all the regions”.
The chart below would seem to suggest switching some focus from US markets to my own favorite, namely emerging markets.
Obviously, these institutional views should be treated with a large dollop of caution but in reality, the funds flow data coming out at the moment does back up this mildly optimistic view on risk assets.
Back at Deutsche Bank, their analysis points to record inflows again into risk assets.
“The last 2 months of 2020 saw the strongest inflows (+$190bn) into equity funds (ETFs and mutual funds) on record. As a proportion of assets under management (+1.1%), these flows were the second largest in the last 10 years, eclipsed only slightly by those at the beginning of 2013. The first week of 2021 has seen strong equity inflows continue (+$11bn)….Equity inflows follow enormous outflows for over two years. Recent inflows represent only a small turn around after huge persistent outflows which began in 2018 (-$725bn cumulative) and are also dwarfed by the inflows into bonds (+$1 trillion) and MM funds (+$2 trillion) over the last 2½ years.”
My own suspicion is that we’ll see continued inflows into more cyclical sectors. That’s backed up by the Deutsche funds flow data – “ since the November elections, cyclical sectors have seen inflows surge with Financials (+$13bn) leading, narrowly ahead of Tech ($12.9bn) and Energy ($11.8bn). As inflows into the cyclicals accelerated, those into ESG and secular growth funds slowed somewhat. This week, Energy (+$1.9bn) funds saw their strongest inflows since 2014, while robust inflows into Financials (+$1.9bn) and Materials (+$0.9bn) also continued. By comparison Tech (+$0.6bn) saw muted inflows.”.
That last point feels about right. Tech seems to have gone slightly off the boil.
But back at SocGen there is word on one last big structural factor worth drawing attention to – what might happen to the dollar. The cross-asset strategy team at the French bank suggest that protecting against a fall in the USD from highly inflated levels is a core investment theme in 2021.
“This theme seems to be playing out, as recent developments in Washington show that the new balance between fiscal and monetary policy seems to favour of the latter, to the clear detriment of the US currency. We recommend keeping low weightings in USD and diversifying into a wide array of currencies, including the euro (recovery fund likely to be voted on during 1Q21), the yen (the Bank of Japan being less dovish than the Fed itself), some EM (through equities) and, newly introduced into our allocation, sterling, which should benefit from its low valuation, low positioning and better visibility after the Brexit deal”.
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