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Not What It Seems

At first sight, the current stock markets dynamics suggest that investors are confident about the macroeconomic outlook and in full ‘risk-on’ mode. A glimpse at the levels of the various indices across the globe says as much, as confirmed by a single look at the MSCI AC World Index which stands at a peak, up 3% since the beginning of the year. Even the deadly Coronavirus has not derailed investors’ enthusiasm.

The reality is factually different. Consider the following:

  • Growth/Quality stocks have massively outperformed Value/Cyclical stocks since the beginning of the year, hence the ‘tech bull run’ headlines peppering the media. This pattern is also observable in the Industrial Technologies space where ‘High Quality’ industrials are trading at a mammoth premium of more than 50% over the ‘Average Joe’. This polarized positioning does not suggest much confidence in a cyclical upturn

  • The 10-year U.S. government bond yield stands below 1.50%, down from 1.90% at the beginning of the year, which here again does not indicate much excitement about the macroeconomic environment, on the contrary

  • The U.S. Dollar has appreciated by more than 3% versus the Euro since the beginning of the year, bringing the Euro to a three-year low which is consistent with investors’ bias towards Growth as opposed to Value. Indeed, the U.S. benefit from a higher growth potential that Europe and from a large tech exposure whilst Europe is intrinsically more cyclical (see ‘Transatlantic Market Dynamics’ in Feb ’17), adding that the Old Continent currently has a more significant exposure to the Coronavirus via its closer ties with China than the U.S.

  • An ounce of gold, an asset synonymous with safety, is currently worth more than $1,600 which is 20% above its level twelve months ago

Based on these observations, the current investment style appears to be rather cautious, with investors implementing a hedge strategy: long equities, but with an extreme defensive twist; and long government debt, long USD without forgetting long gold for good measure…. Belt, suspender and parachute! With a wicked circularity: the lower the interest rates, the lower the discount rate, the higher the rating of stocks with long duration, i.e. Growth stocks. In other words, the beast is feeding on itself.

One of the possible scenarios from now on when considering the market momentum and the fear of missing out phenomenon would be for investors to actually turn ‘risk-on’. A ‘Great Rotation’ into Value, if it happened, would have to rely upon the assumption that the global economy proves resilient to downward pressure (delayed headwinds from the trade tariffs and the Coronavirus), noting that this hypothesis will be heavily challenged by Q1 which will not be pretty from a macro- and microeconomic perspective.

Market cycles do a great job at concealing structural trends, including the fact that the U.S. has been stuck in a 2x2x2 regime since the Great Recession: 2% growth rate, 2% inflation rate and 2% long term yield (with something which looks like 1x1x0 for the Eurozone). A deviation from that trend is unlikely in the foreseeable future, as argued in ‘Shifting the Goalpostslast year. In the context of a world which has gone ex-growth, the tension between Growth and Value within each Industrial Technologies Group will remain elevated and continue to drive corporate portfolio management strategies in line with The Great Industrial Split theory – independently from the stock markets’ moods.

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