In 2020, the World economy It plunged into an unforeseen recession as governments tried to slow the spread of the coronavirus, imposing nationwide closures and restrictions on mobility. As a result, stock indices fell at a rate hardly seen before, ending the longest bullish period in history.
But thanks to swift action by major central banks and governments, investors became more optimistic. The avalanche of liquidity, and the fiscal support, translated into an increase in the demand for assets in the financial markets, driving up the prices of stocks and bonds.
The accommodative monetary policies around the world they drove global bond yields to historically low levels. In the US, 10-year yields hit a record low of 0.51% in August, and many eurozone countries now issue negative yielding debt.
Even though low interest rates boosted equity indicesEspecially in the US, there was a huge divergence in returns between sectors below the surface. The most cyclical segments of the stock market, such as banks and energy, were around their lowest level in decades.
The main beneficiaries of the pandemic have been above all, companies in the US technology sector, which has an important weight in the S&P 500. The change in habits towards teleworking, and the search for entertainment at home, boosted the actions of the companies whose products satisfy that demand, for example, Netflix, Zoom and Logitech, among many others.
During the initial phase of recoveryAn uncertain economic environment, coupled with high liquidity, caused investors to focus only on certain sectors of the stock market, such as the aforementioned technology companies or renewable energy companies.
The Nasdaq index, which is heavily weighted by the technology sector, gained more than 40% in 2020, including the sharp drop in prices at the beginning of the pandemic. Investors largely avoided cyclicals and so-called “Value” stocks, even months after the S&P 500 started to rise.
Vaccines marked the beginning of the sectoral rotation
The change in the trend in yields began to be felt in the fourth quarter of last year, when it became clear that the approval of the first vaccines was approaching. A news that caused changes in market sentiment, as investors began to focus on the sectors that had the most to gain from a return to normal, for example, banks, cars, travel, etc.
At that time, many of the values FAANG (Facebook, Amazon, Apple, Netflix and Google) – all of them benefited from the lockdowns induced by the pandemic – reached all-time highs, and have traded below those levels since then.
Joe Biden’s victory was another factor that added to the rotation of the sector towards cyclical companiesas its electoral promises were seen by investors as reflationary, including a large pledged sum for fiscal stimulus and investments in green infrastructure. Additionally, on January 5 of this year, Democrats unexpectedly gained control of the Senate, increasing the likelihood that Biden’s plans would come true.
So while equity performance so far this year might seem like a mere continuation of the good performance of equities over the past 12 months, the reality is that the ranking of relative winners and losers has changed dramatically. The optimism about vaccination, combined with a very relaxed monetary policy and higher fiscal spending, especially in the US, has once again favored cyclicals and value.
Higher returns and their consequences for equities
Many circumstances suggest that a strong rebound in the world economy in 2021. There is huge hidden demand from consumers, savings rates in many regions are at high levels thanks to government support, and economies and tourism should slowly but surely reopen as vaccination progresses. As the Fed does not appear to be concerned so far about a sustainable pickup in inflation, Investors are testing the limits of the central bank by selling bonds and raising yields.
Broadly speaking, rising returns can be interpreted in two ways: Long-term returns reflect expectations of economic growth, so a rise in returns means investors expect growth to accelerate, which is positive. . However, returns are also correlated with inflation expectations. If this ratio increases, the returns do too. Hitting the Federal Reserve’s 2% inflation target would be positive, but if inflation soars, bond sales are expected to continue.
Yields on the 10-year bond in the United States have risen more than 70 basis points so far this year, and more than 100 basis points from their all-time lows. In Europe, the yield of the German bund has also risen since the beginning of the year, although not to the same extent as its US counterpart.
The increase in yields puts pressure especially on assets with high valuations, many of which belong to the category called growth. The reason is that the profits of these companies are long-lasting, which means that due to their strong estimated growth rate, the profits are expected to be much higher in the distant future. However, if rates go up, the present value of distant earnings decreases due to the higher discount rates.
The most vulnerable market segments are the ones that performed best in the initial phase of recovery, that is, the large technology companies and renewables. For this reason, the tech-heavy Nasdaq index has only risen about 1% this year, while the industrial-heavy Dow Jones has gained more than 7%.
The sectors most exposed to the cycle, such as banks, energy or cars, They have an advantage in this scenario, as their benefits are short-lived, which means that earnings react quickly to the improvement in the economic environment and are less affected by rising interest rates.
So far this year, there has been a strong top performance of cyclical and value stocks. In terms of regional performance, Europe has outperformed the US in 2021, thanks to its greater exposure to cyclical sectors.
Where are we headed?
Currently, for Erste AM, the most likely scenario is that cyclicals and “Value” will continue to outperform relative. All over the world, economic growth forecasts they have recently been corrected upwards, and earnings forecasts point to a strong double-digit percentage increase in both the US and Europe.
If the vaccination program continues to be successful, and proves its effectiveness also against the new variants of the coronavirus, everything points to a strong rebound in economic activity, especially in the second half of the year.
Since September, they have gradually increased their exposure to cyclicals and have taken profits on some growth stocks that performed positively over the past year.
Your opinion is that at this time, The most appropriate thing is to have a balanced portfolio in terms of “Value” versus “Growth”, and that a specific weakness in the market should be used to increase the positions in cyclical values and “value”.