If we opened today’s Perspectives with the news that equity markets are up modestly in the third quarter, you might not be impressed.
But what if we noted that bank stocks have rallied more than 10% since late August? Or that last week momentum indices, which put their biggest weights in stocks with the best recent performance, experienced their worst crash since the financial crisis?
While it all balances out at the market-index level, recent days have witnessed a violent reversal of some well-established trends. We described a number of these trends, such as the performance of large- versus small-company stocks, defensive versus cyclical sectors and low-beta versus high-beta exposures, in our last Asset Allocation Committee Outlook, and suggested they might be ripe for the kind of turnaround we have seen this month.
Is it just mean reversion at work? Wrong-footed momentum traders covering short positions? Or is it a sign that investors have become less concerned about the economy?
Collapse in Momentum
As evidence of what is being called the “momentum massacre,” look no further than the sudden underperformance of growth stocks versus value stocks since the start of the month. It has been as severe as we have seen for a decade, after months of growth leading the market. Defensive stocks such as real estate securities and utilities have swapped position with cyclicals, large caps with small caps. After lagging severely all year, Japanese equities have left U.S. equities standing in September.
These rotations could be explained in simple and consistent terms. Investors will pay more for growth stocks if they fear a broad slowdown in the economy. They will pay more for the steady income streams of defensive stocks if they fear a slowing economy is going to push down bond yields. A reversal of these trends would be consistent with expectations for higher growth, higher inflation and a reduction in geopolitical risk.
It is encouraging to see the same tides pulling at bond markets: The start of the month has given us the sharpest sell-off in U.S. Treasuries in three years; the inversion of the two- and 10-year points on the yield curve, which caused so much worry last month, has turned positive again; 30-year German government bond yields that had been negative since the beginning of August climbed back above zero last week.
Stimulus in the Pipeline
While economic and geopolitical news may have become modestly more positive lately, we are cautious as to whether this justifies these startling market reversals.
New U.S.-China trade talks have been scheduled, additional tariffs have been postponed and Brexit is potentially delayed again, yet the major issues around these risks remain unresolved.
While the latest U.S. labor data was tepid at best, we are seeing more hiring and upside surprises in wage growth, both of which are leading indicators of higher inflation. The U.S. and China both reported higher-than-expected inflation last week.
Behind the obvious malaise in global manufacturing, Composite Purchasing Managers’ Indices are beginning to stabilize.
And there is more stimulus in the pipeline.
The People’s Bank of China just added another rate cut to the measures implemented already this year. The European Central Bank also cut rates, as well as restarting its asset purchase program, taking measures to ease the damage of negative rates on the banking sector and adopting new lower-for-longer guidance. There has even been talk of a “shadow” budget in Germany, dedicated to infrastructure and climate protection and designed to get around tight fiscal rules.
We will need to see more to sustain the market’s new trends. Two weeks do not make a recovery, and the likelihood of recession is still higher now than it was three or six months ago. But traders appear to have recognized that the prospect of a soft landing is not as remote as they were pricing for in the pessimistic, illiquid summer markets. And however the data pans out for the next few months, recent reversals remind long-term asset allocators to stay ever mindful of extremes in momentum, valuation and market consensus.
In Case You Missed It
- Japan 2Q 2019 GDP (Final): +1.3% annualized rate
- U.S. Producer Price Index: +0.1% in August month-over-month and +1.8% year-over-year
- U.S. Consumer Price Index: +0.1% in August month-over-month and +1.7% year-over-year (core CPI increased 0.3% month-over-month and 2.4% year-over-year)
- European Central Bank Policy Meeting: The Governing Council cut its deposit rate by 0.10% to -0.50%
- U.S. Retail Sales: +0.4% in August
What to Watch For
- Tuesday, 9/17:
- NAHB Housing Market Index
- Wednesday, 9/18:
- U.S. Housing Starts and Building Permits
- Federal Open Market Committee Meeting
- Bank of Japan Central Bank Meeting
- Thursday, 9/19:
- U.S. Existing Home Sales
- Japan Consumer Price Index
Statistics on the Current State of the Market – as of September 13, 2019
|S&P 500 Index||1.0%||2.9%||21.7%|
|Russell 1000 Index||1.0%||2.7%||21.7%|
|Russell 1000 Growth Index||-0.4%||1.1%||24.6%|
|Russell 1000 Value Index||2.5%||4.5%||18.9%|
|Russell 2000 Index||4.9%||5.6%||18.2%|
|MSCI World Index||1.3%||3.2%||19.4%|
|MSCI EAFE Index||2.0%||4.3%||14.8%|
|MSCI Emerging Markets Index||1.9%||4.4%||8.8%|
|STOXX Europe 600||1.5%||4.0%||15.4%|
|FTSE 100 Index||1.2%||2.4%||13.6%|
|CSI 300 Index||0.6%||4.6%||34.9%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||-0.5%||-0.5%||2.6%|
|Citigroup 10-Year Treasury Index||-3.1%||-3.5%||8.5%|
|Bloomberg Barclays Municipal Bond Index||-1.1%||-1.2%||6.3%|
|Bloomberg Barclays US Aggregate Bond Index||-1.7%||-1.8%||7.1%|
|Bloomberg Barclays Global Aggregate Index||-1.4%||-1.5%||5.8%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||0.6%||0.8%||8.3%|
|ICE BofA Merrill Lynch U.S. High Yield Index||0.1%||0.4%||11.6%|
|ICE BofA Merrill Lynch Global High Yield Index||0.3%||0.7%||10.4%|
|JP Morgan EMBI Global Diversified Index||-1.4%||-0.7%||12.7%|
|JP Morgan GBI-EM Global Diversified Index||0.7%||2.3%||9.3%|
|U.S. Dollar per British Pounds||1.2%||2.3%||-2.2%|
|U.S. Dollar per Euro||0.3%||0.6%||-3.0%|
|U.S. Dollar per Japanese Yen||-1.2%||-1.8%||1.5%|
|Real & Alternative Assets|
|Alerian MLP Index||3.5%||2.7%||13.3%|
|FTSE EPRA/NAREIT North America Index||-1.4%||0.0%||22.2%|
|FTSE EPRA/NAREIT Global Index||-0.4%||0.9%||17.6%|
|Bloomberg Commodity Index||1.1%||2.3%||4.3%|
|Gold (NYM $/ozt) Continuous Future||-1.1%||-2.0%||17.0%|
|Crude Oil (NYM $/bbl) Continuous Future||-3.0%||-0.5%||20.8%|
Source: FactSet, Neuberger Berman.