Please see the below date from Legal & General’s Asset Allocation Team received late yesterday afternoon:
Waking up
Last week was a bit more eventful than the big yawn of the previous week. Rates and inflation expectations drifted up, even more so after Federal Reserve chair Jerome Powell’s speech at the Jackson Hole Economic Policy Symposium indicated the central bank will now look to achieve an inflation rate averaging 2% over time. In addition, Shinzo Abe, the longest-serving Japanese prime minister since the Second World War, resigned and Germany, France, Italy and Spain all experienced accelerating case loads of COVID-19. James Carrick has blogged about developments in the latter country.
Investors can’t get too excited
Overall, sentiment and positioning remain quite neutral. For instance, one of our favourite indicators, the AAII Bull-Bear spread, is still negative and fund-manager cash levels are only neutral. Even sentiment in technology stocks isn’t that exuberant, as I discuss below.
We believe market sentiment is being held back by the general belief that assets have overshot fundamentals. We see some rationale for that in equities, credit and gold. Growth expectations are at their highest since December 2009, albeit from a very low base, and the economic surprise index – which is mean reverting by nature – is close to an all-time high. As investors adjust their expectations up, the market is now more prone to disappointments.
We therefore remain neutral on risk, but are starting to short areas where risks look asymmetric – US investment-grade credit, for example, and EU/GBP inflation. Our rates team likes to be long some markets with higher yields such as Australia, South Korea, and the long end of the US.
What the tech is going on?
It has been another good run for tech. The sector is back at its relative highs from July and, whisper it quietly, even the dotcom bubble’s relative highs from 2000 don’t look that far away anymore. The price charts for some tech names are starting to look exponential.
So is it time to sell the rally or hold on for the ride? We have long had two guiding principles for tactically reducing our tech position: excessive valuations and/or excessive bullishness. Neither signal has turned red yet.
On the first, outperformance has been driven by superior earnings rather than by valuations. In fact, the relative price-to-earnings ratio remains roughly where it was in January. Staying long tech requires a belief in a step change in relative earnings, but in principle this does not feel like a big stretch.
On sentiment, it is impossible to argue that tech is a particularly unpopular sector. But we don’t see signs of excessive bullishness either. The most recent institutional investor surveys actually showed a small decline in positioning. On the increasingly important retail front, Robinhood data show that while there have been flows into tech recently, private investors remain underweight the sector. So, for the time being, we choose to hold on for the ride.
COVID-19 and belief-scarring
An interesting paper has been published that tries to quantify how people’s long-term belief systems have changed because of the pandemic (Kozlowski, Veldkamp & Venkateswaran 2020).
The largest economic cost of COVID-19 could arise from changes in behaviour long after the immediate health crisis is resolved. A persistent change in the perceived probability of an extreme, negative shock in the future affects behaviour. You see a similar phenomenon when people go through deep personal crises due to war or natural disasters.
The authors find that the long-run costs for the US economy from this channel are many times higher than the estimates of the short-run losses in output. This suggests that, even if a vaccine causes the virus to disappear in a year, the COVID-19 crisis will leave its mark on the US economy for many years to come.
The authors conclude that considering the long-run consequences significantly changes the cost-benefit analysis for financial support policies (i.e. providing more fiscal support now to prevent scarring could help GDP growth in the years to come).
This email represents solely the investment views of LGIM’s Asset Allocation team.
As we noted in last week’s Legal & General update, it’s good to have an insight into how some of the big investment companies Asset Allocation teams think, this is just one of the ways that we at People and Business get a view on current market trends and how these are being factored into investments funds and portfolios.
Keep checking back for more updates as we continue to provide commentary from a range of industry experts to keep you updated as we continue to navigate our way through these strange and unprecedented times.
Andrew Lloyd
02/09/2020