Please see below article received from Legal & General yesterday afternoon, which provides a market insight from the Head of their Asset Allocation team.
The mood swings, finally
Over the past week, after the election and vaccine news, investors’ animal spirits seem to have emerged at last. The AAII Bull/Bear spread, one of the indicators we rate most highly, jumped to its most bullish reading in nearly three years and one of the highest since the financial crisis. Recent fund-manager surveys from BAML, Strategas and ISI showed a similar surge in investor optimism.
To cap things off, the first sell-side outlooks for 2021 have also been more optimistic than both the historical average and last year’s ‘mid-single-digit upside’ consensus. The average S&P 500 target for end-2021 from Goldman Sachs, Morgan Stanley and Credit Suisse suggests 15% upside from here.
But despite the notable spike in investor bullishness, our own indicators are not sending contrarian sell signals yet. Our interpretation is that sentiment has simply become a headwind, rather than so excessively bullish that it starts to dominate our thinking about equity risk. Even at the latest reading of 31% net bulls in the AAII survey, for example, the average return over the following 12 months has been +6.3%, not far below the average return in any 12-month window. Historically, only readings above 40% net bulls have been significant sell signals.
Holding onto the barbell
We have been running a barbell strategy within equities since the spring. On the one side, our highest-conviction long is one of the most loved parts of the market, the secular growth story in tech. On the other side, we also like some of the least loved deep value and recovery plays in the form of telecoms, travel and leisure, and cyclicals.
European telecoms easily meet the deep value criteria with attractive relative valuations compared with history and regularly score as one of the least popular parts of the equity market. But a deep value case only has merit if there is a potential catalyst on the horizon. We see this in the likelihood of the sector benefitting somewhat from greater regulatory leniency and possibly some modest pricing-power gains in a post-pandemic environment. From a multi-asset perspective, telecoms also offer us some diversification with low correlation to broader equities and a low beta in equity drawdowns.
‘Cyclicals versus defensives’ is an obvious play on a strengthening economic cycle. Having recovered a lot of the pandemic losses since the spring, we see no overshoot against the improving macro data yet. With sentiment for cyclical sectors also remaining less optimistic than for defensive sectors, we expect this trade to have more room to run in the remainder of the economic rebound.
Value stocks and the travel and leisure sector both score well on sentiment (the consensus on them is bearish) and should both benefit particularly from the next phase of the economic re-opening dynamics. With the vaccine announcements behind us, we still expect generally positive macro news flow with a restart of travel activities and pent-up demand.
Calmer waters for a while
The New Political Paradigm (NPP) has been one of our medium-term themes as a framework for thinking about the market impact of gradually growing populist pressures.
As with so many things, the pandemic has accelerated the underlying trends of the NPP. The jump in food inflation does not affect everyone the same way. Job losses have been most severe among the lowest-earning groups, for multiple reasons. School closures have widened the education gap between students from different economic backgrounds. The Edelman Trust Barometer at the start of the year showed a significant gap in optimism about the future in different parts of developed markets’ populations before the pandemic hit. That gap is likely to be wider now.
The US election, however, should help keep some of the most market-moving elements of the NPP policy mix off the agenda for the time being. A Biden presidency should provide a calmer style in the US approach to China and trade policy in general, even if there is little change in substance. And with a divided congress, an aggressive change in fiscal policy (e.g. to modern monetary theory, universal basic income, or Medicare for All) has become all but impossible.
So overall, the NPP will likely be quiet for a while, but our expectation is that the underlying trends that gave rise to populism stay in place and become market drivers again in the years ahead. In the meantime, our mantra remains ‘don’t predict, prepare’.
We will continue to publish up to date content sourced from a wide variety of investment experts. Please check in again with us soon.
Stay safe.
Chloe
24/11/2020