It’s fast approaching that time of the year where we’ll get wall-to-wall end-of-year/beginning of year predictions. Pimco has been quick of the mark and has outlined what I think is probably a consensus view, namely broadly positive on equities, especially US growth stocks:
“ We remain broadly constructive on equity market risk. We expect to see substantial differentiation across regions and sectors, which warrants a more selective and dynamic approach. Within developed markets, we remain overweight U.S. equities and have positioned our overweight in cyclical growth sectors. We also have exposure to Japanese equities, which tend to have a valuation cushion along with beta to cyclical growth. We view European equities as more challenged due to a combination of unfavorable sector composition, energy price headwinds, and growing unease around the COVID-19 outlook…..In emerging markets, we continue to be constructive on select exposures within Asia. Simultaneously, we are closely monitoring regulatory developments in China and evolving geopolitical tensions in the region. We remain overweight emerging Asia, with an emphasis on hardware technology and equipment that will be foundational to regional as well as global growth…..From a sector perspective, we retain a preference for secular growth trends like digitalization and sustainability. In particular, we believe that semiconductor manufacturers, factory automation equipment providers, and green energy and mobility suppliers all stand to benefit. We complement this with exposures that may benefit from a more inflationary environment; these are companies that we believe have significant barriers to entry and strong pricing power that can potentially harvest inflation through price increases, such as global shipping companies.”
For equity investors, my guess is that the big decision most of us will face is whether to stay invested in growth stocks or finally rotate out into cheaper cyclical or value stocks. I’m probably still overweight growth stocks but I continue to be concerned about valuations that look more than a tad expensive. A PE of 35 to 45 is the new norm, it seems. The challenge here is that when growth cracks, the subsequent retreat is usually fairly painful. A new piece from the GMO Asset Allocation Team introduces the concept of ‘growth traps’ which they claim are even more insidious.
“The seduction is different, borne from grand narratives of disruptive technologies, hyper-growth, and breathtaking breakthroughs. But Growth stocks are no less prone to disappointment – there’s actually evidence they are slightly more likely to disappoint at certain points in the cycle – and their punishment can be even more dire.”
Next up, a useful primer on the yield spread by Tricio’s Chief Strategist Gerry Celaya. The chart below shows the spread for the US and the UK – it measures the spread between 2 and 10-year government bond yields.
“The manner in which both these curves seem to broadly move in tandem highlights the correlation in economic growth and recessions, to some extent. Right now, the focus is on the long end of the curves – the 10-yr. note and Gilt yields, as both the Fed and Bank of England meet this week to decide on stimulus and rate policy. If the market takes whatever happens as positive for economic growth, then the long end yield should tick higher. The market may well take the view that whatever the Fed and BoE do, inflation will come down over time (pressuring long-dated yields lower), but the curve does give insight into growth prospects as well. Which is why investors tend to think that a steeper curve (bigger positive spread) is good for stocks (financials especially as banks can borrow short and lend long), while a flattening or negative curve is really bad for economic prospects, and stocks. Simple really, while central bank policy pushes the 2-yr. yield around (anchored to fed funds or base rates), it is market sentiment around the 10-yr. debt that is key.”
Quite. My rough ready reckoner is that once the UK 10 year yield heads above 1% you should move to a more cautious position and once we are above 1.25% to 1.5% think about taking more risk off the table.
I couldn’t help but finish with this fantastic graphic showing how we collectively spend our time on the internet. It’s obviously missing a few categories (porn) but includes platforms I’ve never even heard off (Imgur) plus platforms I’m unlikely to ever visit like Twitch (2 million views per minute). And the highlight – 2 million swipes per minute on Tinder.
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