The opposite to US growth is not US value
If investors decide to get out of the growth style in the US, there are several other strategies they can follow apart from US value: (1) low volatility in US equities; (2) growth in non-US equities; (3) low volatility in other US asset classes; (4) non-US value. The problem with the value style is that cheap stocks tend to stay cheap, unless there is a clear and obvious catalyst for them to outperform, like a massive earnings surprise (as in Energy) or a surge in corporate activity (which may happen in the UK). We think the most popular destination for flows out of US growth will be low volatility in US equities, into sectors such as Consumer Staples and, possibly, Utilities.
Everything depends on the slope of the yield curve
We see lots of commentary suggesting that the value style is going to outperform the growth style in Europe and the US. We also see this being used as a reason for rebalancing global equity portfolios away from the US and towards Europe. We disagree with both ideas and also with the big idea behind them, which is that government yield curves are going to shift higher and/or steepen at the same time. Indeed, the recent behaviour of US Financials suggests that investors are becoming concerned about the yield curve inverting over the medium term. We also think that the new emphasis on ESG guidelines makes the value/growth trade much more complex than it used to be.
Chinese Technology could lead a rally in EM Equities
We spend a lot of our time dissuading clients from going bottom-fishing, mainly because it doesn’t work very well. But there are times when we may need to do it to protect ourselves from the risk of being underweight a sector or country which rallies very fast. This week we highlight a combination of charts (EM Equities and China vs the World and Chinese Technology vs China) which have all sent recent signals suggesting that we may need to close our underweight positions in a hurry. There is a risk/opportunity that Chinese Technology could lead sharp and unexpected rally in EM Equities.
Three rules for how to do it
Nothing in the last two weeks has changed our view that a correction in global equities is coming. If you are one of those investors who has waited all year to buy the dip, we have three rules about how to do it. One, decide your tactics in advance and don’t pay too much attention to the narrative behind the correction. Two, don’t add complexity to a market timing trade by using it to rebalance your equity portfolio. Three, if you want to front run a correction, make sure you have enough defensive exposure at a sector level. Our top pick here is European Telecom.
The bottom is not bouncing to the top
There has been a lot of excitement about factor rotation in equities, but it’s mostly based on the back of two days’ trading at the start of this week. We agree that rotation is going to pick up, but from a very low base and our work suggests that it’s going to be from the top to the middle and vice versa. We think that the laggards, like Financials, Energy and Telecom could underperform for some time to come. If the factors in question are meaningful, they will show up in sector performance fairly soon. If not, perhaps they are not as important as reported.
Some US Tech giants are already rated underweight
We re-iterate our call to take profits in US Tech. We have downgraded Communications to neutral this week and we already have Google/Alphabet as an underweight. The Tech sector broke down through an important technical signal in late August and is now accelerating towards a downgrade. Leading stocks like Microsoft have been downgraded and only Apple looks robust at current levels. The majority of the large stocks we cover have lower scores than they did at the end of summer.
Cause for concern in Technology and Financials
China’s stock market is always subject to official intervention, so the signals need to be interpreted carefully. However, there are two new red flags in our equity sector model, relating to Technology and Financials. Technology has suddenly started to deteriorate, which has historically been a good lead indicator for the US Tech sector. Financials are heading for a multi-year low relative to the index, which could have important implications for China’s FX policy regime.
Time to take profits in US Tech
The US Tech sector has just flashed an important warning signal. Our recommended weighting has just dropped below its 52-week moving average. This has happened seven times in the last 25 years and the result is always a significant reduction in exposure. Six times out of seven, the sector has not bottomed until it was deep in underweight territory.
Consensus is looking for mean reversion in the wrong place
Three interesting ideas emerge from our regular reports. First, the volatility shock will almost certainly be as bad as 2008. Second, we believe that a long Technology /short Energy trade will have a positive pay-off no matter whether equity markets rise or fall. Third, our models are increasing exposure to EM Equities. We recognise this is a contrarian trade, but it is well-supported by our process and doesn’t depend on one or two countries.
Or the fat lady is about to sing (choose your own metaphor)
Apple and Microsoft both look significantly overbought relative to US equities. Other US stocks with similar scores have underperformed by about 15% over the next three months. If this happens to the two largest stocks in the index, US equities will probably fall.