As we read through near and long-term 2021 views, we see something bothersome – everyone has the same calls. Market consensus is, by definition, a general agreement. If investors are positioned in line with a general consensus, then the odds of making money on consensus calls are slim. Put another way, if everyone is in agreement, where does the marginal dollar come from to push prices higher in the consensus trade?
From our observations, consensus calls for 2021 include:
- Overweight non-US equities (excluding emerging markets) vs. US equities
- Overweight in emerging market (EM) credit
- Overweight high-yield fixed income vs. investment grade (IG) fixed income
- Short the US dollar
- Go long on Bitcoin
As of mid-December, EM credit does look cheap to its comparable credits and it seems possible that the US dollar could trade more softly – its value gradually decreasing – over the near term. But with so many market watchers calling for non-US equities to rally, it’s pertinent to ask what could be missing from that story. As we’ve written previously, we see these rallies unfolding in stages:
- Phase 1: “Just get me in.” Here, investors pile into the market after important news hits, like Covid-19 vaccine headlines. There’s a scramble to own whatever might provide the best pop in near-term value.
- Phase 2: “Buy the laggards.” This could also be called the “Fear of Missing Out” trade, where people who missed Phase 1 experience anxiety and start itching to get in. They don’t want to buy the high-flying stuff that may have already popped, so they look for whatever might have lagged and buy that.
- Phase 3: “Buy business fundamentals.” When the dust settles and the frenzy of Phases 1 and 2 calms down, business fundamentals come back into play. Investors become more likely to take a step back and question why certain assets or names are up as much as they are before rotating into the stories that better support relative value.
It’s important to note that these “phases” are not uniform across the risk spectrum. There is no single cycle that casts a wide net over everything. Certain segments of the market can be in one phase, while others are in their own.
Take, for example, the 1-month returns for Small Caps and Large Caps as of December 11. Here’s a sector perspective breakdown:
|1 Month (%)|
* The S&P SmallCap 600 covers approximately 3% of the domestic equities market. Measuring the small cap segment of the market that is typically renowned for poor trading liquidity and financial instability, the index is designed to be an efficient portfolio of companies that meet specific inclusion criteria to ensure that they are investable and financially viable.
** S&P 500® Index is a widely recognized measure of U.S. stock market performance. It is an unmanaged index of 500 common stocks chosen for market size, liquidity, and industry group representation, among other factors. It also measures the performance of the large cap segment of the US equities market.
There is evidence that Covid-19 vaccine news kicked off a “just get me in” phase. We saw cyclicals take off as the fast money chased the beta names in developed markets. Later, in the “laggards” phase, news of a light at the end of the tunnel – a pandemic reopening at long last – helped create a rotation: sell tech to buy energy and banks. As it stands, there is probably more room for the reopening trade to run, which helps the international developed market story. But what happens when the market moves to Phase 3? Fundamentals take over. This is where we start to have a bit of a different review than the current consensus on international developed.
We keep asking ourselves – what has changed since the end of 2019? Yes – there was a public health and economic crisis as a result of the Covid-19 pandemic. What resulted was all sorts of global fiscal and monetary policy designed to smooth things over. As of mid-December, we’ve got low rates and quantitative easing1 in overdrive. But weren’t these already in place at the end of 2019? Yes, rates are even lower and QE has purchased even more debt, but in a general sense – aren’t we just back to where we were?
In terms of fiscal policy, governments have spent a ton of money to support labor markets. Yes, some have spent more than others. Yes, some have issued grants and some have offered loans. But as we’ve written throughout the year – these were income replacement measures, not market stimulus measures. Said differently, there was really no new net funding put forward; there was a very large effort undertaken to shore up what was otherwise going to be lost.
Taking this argument further, what has changed in Europe since the end of 2019 that makes so many investors excited about the international developed trade? Sure, there will be a catch up trade, but then what? There have been no structural changes to the European economy. Yes, the EU Recovery Fund – after its slow approval process is finally completed – removes the risk of a potential EU breakup, but is it a game changer?
When we look at this market backdrop, it looks familiar. It looks like the end of 2019. Assuming that Covid-19 vaccine distribution and uptake challenges are at least generally met, a return to relative normalcy by the end of 2020 looks reasonable. There is understandable excitement among many investors about the catch-up trade, but a consideration of fundamentals will eventually have to follow. The less exciting stuff. How have business fundamentals improved? What measures have been taken to improve growth prospects?
No one in their right mind would argue that we’re living in the same world we were living in back in December 2019. Yet, from an investment perspective, we believe the best 2021 market outlook may not be a generalized statement related to a catch-up trade, but a question about what comes after – what has changed?
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