Momentum in reverse?

Could 2021 see a continued rotation from growth to value stocks or was the November rally a short-term bounce? Max Anderl looks at the impact on portfolios

03 dez 2020

What are the implications of the US election result and the recent discoveries of COVID-19 vaccines?

While the US election is largely behind us, the likely split of power between Democratic President Joe Biden and Republican Senate indicates that there is less scope for modern monetary theory (MMT) policies than we would have expected in a Blue Wave.

As for the vaccine discovery, we always believed that science would win this battle and it was only a matter of time.

What surprised us, however, was the "shock" reaction of the market that followed these events. This resulted in a record move in factor rotation in one day on 9 November (see Exhibits 1 and 2). It is hard to believe the extent to which the market reacted based only on headline vaccine news without any certainty of the duration of protection.

Our strategy was hit hard on a relative basis as lower quality stocks staged a stronger than expected rally. Many companies with limited medium term growth expectations re-rated while companies with strong growth hardly rose.

Exhibit 1: 1-day return of momentum factor

A record one day move in factor rotation following vaccine news on 9 November

Exhibit 2: S&P500 cross sectional dispersion

Daily standard deviation of single stock returns

Cross-sectional volatility and stock returns looking at how dispersed the returns are and the impact following vaccine news on 9 November

Bullish sentiment factors such as those from the American Association of Individual Investors have moved sharply into positive territory (see Exhibit 3). Fund manager surveys also show that growth and profit expectations are at a 20-year high, as well as that optimism towards small caps and yield curve expectations are at an all-time high.1

Exhibit 3: American Association of Individual Investors, Sentiment Survey Bullish

American Association of Individual Investors, November 2020

Individual investors are now optimistic and bullish sentiment has increased according to the American Association of Individual Investors

We are open minded about possible regime changes. For a lasting regime change we will firstly need to see a rise in inflation expectations followed by a confirmation. 

With rising hopes in regards to a vaccine, we believe 2021 is likely to be a less turbulent year and therefore leading indicators and year-on-year GDP growth are expected to be very positive next year. We also expect inflation to rise. However, we have to bear in mind that the GDP starting base is very weak.

How will financial markets react?

Clearly, with surveys reporting optimism, growth and profit expectations at multi-year highs, this is a consensus view. Going forward, we do not expect this trend to continue. Instead we would expect the market to return to fundamentals and reward stocks with a strong medium term outlook irrespective of whether they are classified as 'value' or 'growth'.

How have you adjusted portfolios in light of recent events?

It seems that the market is euphoric about the Biden government just as it was in November 2016 following President Trump’s presidential win. Just as we saw in 2016, inflation correlated assets such as banks rallied. In 2016 hopes were strongly rooted in promises of fiscal stimulus via infrastructure spending. While this time around there could be less disappointment in similar hopes, empirically there has always been a large divergence between pre-election political promises and what is delivered in reality, which means that what we see in markets is typically an overreaction.

We therefore continued to take profit in names where valuations have risen over time and reinvested into better risk vs. reward opportunities. Within the IT and consumer discretionary sectors, we took the opportunity to add to some of our long term high conviction holdings on weakness. We also bought into cheaper valued names in the insurance sector.

Unlike 2016, we are already overweight cyclicals versus defensives in the strategy and we aim to maintain this overweight as a recovery play. After all, the factor rotation that we saw in November was the biggest ever recorded move in a single day. The rotation continued over the rest of the month and valuation spreads fell sharply. We remain open minded in terms of adding to our value exposure in the event of a near term correction of style.

We therefore continued to take profit in names where valuations have risen over time and reinvested into better risk vs. reward opportunities.

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