By Kimberly Woody, Senior Portfolio Manager
Rotation – The Earth’s axis has an inclination of 23.5 degrees relative to its orbital plane around the sun. This axial tilt results in variable solar angles at varying latitudes throughout the year, giving rise to the seasonal changes we experience.
A notable transition in relative performance has occurred from technology stocks towards financials and utilities recently. We’ve also witnessed strong rallies in cyclically oriented companies, within consumer staples, that had previously been lagging. The disparity between growth and value stocks, while historically wide, is starting to narrow. This trend raises several questions, primarily “Why now?” and “For how long?”
Some factors are clear. Valuation is regularly cited as a top concern among investors in polls gauging sentiment. A majority of respondents report that they believe the stock market is overvalued. Nevertheless, in the most recent investor sentiment survey by Investopedia, around two-thirds of those surveyed expressed that they feel either “cautiously optimistic” or “optimistic,” marking the highest degree of optimism seen in the previous year. We are seeing what we believe to be election-induced volatility, the direction of which seems to be contingent on shifting poll results. Given that four of the last six elections were not just close, but contested, it is impossible to gauge either the outcome or the impact on markets. Both party’s platforms run the gamut from green energy to unfettered drilling. Key battles in the House of Representatives and the Senate will determine to what extent those policies become reality if at all. To a lesser extent, other subtle elements are also affecting the market, like the yen’s role in global trade dynamics. Though it’s difficult to quantify, the yen’s positioning may affect tech investments at the periphery due to currency implications on liquidity. The Yen Carry Trade, at its core, is an arbitrage strategy exploiting the differential in interest rates between the Japanese yen and other currencies. A stronger Yen of late may reduce liquidity for such trades.
One intriguing observation is the limited scope of the robust market rally over the last 18 months. We posit growth stocks become more attractive when growth is scarce. As such, our strategy favored US large-cap growth during an extended period of low-interest rates since the great financial crisis until early 2020. In a decade characterized by low rates and growth, it’s logical for larger, faster-growing firms to thrive given their favorable valuation at reduced discount rates. Despite the era of ultra-low rates potentially coming to an end, this trend continues, possibly due to drivers such as artificial intelligence and lack of growth in other sectors, causing an imbalance in the marketplace. While we acknowledge the potential of artificial intelligence to herald significant technological and productivity advances, it’s important to remember the cautionary tale from the dot-com bubble burst. The underlying premise of tech-led change was correct, but the associated equity names became excessively valued, resulting in a top-heavy market and subsequent correction. The tangible monetization of the internet’s promise took more than a decade to realize. Blockbuster filed for bankruptcy in 2010. These transitions take time.
Market movements since the beginning of the third quarter suggest anticipation of a September rate cut. While some expect aggressive Federal Reserve cuts, counterarguments exist – economic growth is good according to corporate earnings and GDP readings, yet inflation remains stubborn. Reflecting on the Fed’s previous predicament and that it took a global pandemic to gain any traction in stoking inflation and economic growth, it seems improbable they would ease monetary policy so promptly after the upheaval involved in navigating out of a low-rate environment. Trading around anticipated Federal Reserve policy changes or election results is a difficult and often fruitless endeavor. We encourage investors to remain mindful of their longer-term risk tolerance and objectives. Diversification, the benefits of which have been muted by a very narrow market, remains key to our philosophy in reducing both volatility and downside.
Source: FactSet, Investopedia
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