Stock Bulls Just Got a Wake-Up Call in a World of Confusion
(Bloomberg) -- If complacency was the charge, the market just delivered its punishment.
As the coronavirus spreads and U.S. business activity takes a hit, the S&P 500 Index notched its first weekly decline since January. The yield on 30-year Treasuries dropped to record lows, gold rose to seven-year highs, volatility markets woke up.
Bonds finally got the attention of stock bulls as key portions of the U.S. curve flashed traditional signs of a brewing downturn -- again.
All told, this is a mild setback for stock traders who’ve been pumping up markets to records.
The more pressing questions: Should they heed warnings on global growth ostensibly sounded by their fixed-income peers? Are the defensive strategies that have benefited from those very fears looking expensive?
Abi Oladimeji has one answer.
“Although investors are aware of the need for caution because of the downside risks, once you look beyond that, you look around and you see significant monetary policy stimulus,” said the chief investment officer at Thomas Miller Investment Ltd. in London. “Long-duration trades, from a multi-asset portfolio standpoint, are a hedge against downside risk in equities.”
In this view, investors are largely keeping their risk-on exposures but hedging them with bonds. The Federal Reserve is standing by if risks from the virus spill over to domestic shores. The Goldilocks-lite scenario in a liquidity-driven world is largely intact -- even if the virus undercuts output in the coming months.
At Wells Fargo Asset Management, the multi-asset team’s favored exposure reflects the mixed sentiment in markets now. While it’s still optimistic about equities, especially the tech sector, the fund is also positive on consumer staples and gold.
“People were caught a little flat-footed with the news of coronavirus and the interruption to growth in China and how that then emanates into growth in the rest of the world,” said strategist Brian Jacobsen. “Any weakness that we see in the economic data coming from the coronavirus effect is likely to be short-lived and we could see a snapback.”
Jacobsen is mulling a bet on a steeper yield curve based on the view that global stress has exacerbated declines in longer-dated yields beyond what’s warranted by economic fundamentals.
Investors in one corner of the stock market are faced with an allocation conundrum that’s deepening.
The flattening yield curve has translated into epic gains for equities with fast earnings growth, which are dubbed growth equities and seen as long-duration assets. By contrast, value shares -- many of which are acutely tied to the economic cycle -- are getting hit. That has pushed the valuation of growth over value to the highest since the dot-com bubble. With billions invested in these strategies, there’s a risk of a disruptive rotation.
No wonder then that stretched multiples spurred Bank of America Corp. and JPMorgan Chase & Co. this week to call for a rotation in favor of the beleaguered value strategy.
“The last time we got to these levels, the bubble burst and a 50%+ global bear market began,” Citigroup Inc. strategists led by Robert Buckland wrote in a note, referring to the dot-come era. But “this could get worse before it gets better,” they said.
There were incipient signs of a shift this week, with tech posting the worst performance among sectors as bond-like stocks from utilities to consumer staples beat the pack. Minimum-volatility stocks, with tend to behave like bonds, outperformed the benchmark as borrowing costs plunged.
Whatever happens, all signs suggest stock investors will be living with the epic bond bull market for a good while yet. Fixed-income funds could see $350 billion of inflows in 2020, exceeding an already strong $204 billion in 2019, Bank of America estimated based on trends so far this year.
It helps explain why yields on investment-grade and high-yield companies are trading at multi-year lows and suggests that credit investors are still bullish about the outlook for Corporate America’s cash flows. That’s another reason why stock managers can be sanguine right now.
“There are growth concerns, but they are not significant concerns at the minute,” Thomas Miller’s Oladimeji said. “The bit that we don’t know or nobody knows is what the overall impact of the COVID-19 will be. So our approach is to look at hedging in various guises.”
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