A widely read fund manager survey published on July 14 reported that a record number of respondents now believe that US tech stocks are the market’s most crowded trade. Our response has been “Tell us something we don’t know.” In addition, we have counterarguments to what appears to be a growing sense of mid-summer market skepticism.

The Rally Battles Déjà Vu
The rally off the March lows has been breathtaking – and remarkably resilient – even in the face of continued virus headlines and caseload concerns that can make it feel like we’re back to the peak-crisis days of March all over again. Nevertheless, we would argue significant skepticism has actually been a positive by keeping market sentiment in check. Despite rally skepticism, it seems that investors have turned much more optimistic on the global economy. It could be argued that this is expected, following on the heels of a self-imposed global recession, but in the face of persistent uncertainties and COVID-19 concerns, it is notable.

Potential Growth Opportunities
The idea that many investors are still not willing to take on much risk is supported in part by the fact that equity allocations remain light, bond allocations remain extended, and cash levels remain high. Furthermore, where investors are taking on equity risk, they are doing so in more defensive sectors and regions, namely the US. That investors are skeptical and underexposed to equities makes a compelling bear market case a tough sell.

Investors remain heavily underexposed not only to equities in general, but to cyclical sectors as well. Light positioning here could mean these sectors are primed for a powerful technical rally of the kind we saw during the cyclical rotation of late May and early June. Even without significant improvement on the virus front, cyclicals have perked up a bit during the second week of July. Something to keep an eye on.

Value stocks and banks have been absolutely pummeled in recent weeks. Banks will be a key area to watch as we roll into earnings season – some early-reporting banks have already announced strong numbers. Generally speaking, the bar for banks has been set very low. Positioning remains light, but strong reporting could spark renewed appetite in the sector.

Pictures from Europe
European equities have seen investors come rushing back. While still significantly underowned, positioning in euro stocks has picked up markedly over the last month and investor expectations for the region are high. The idea that Europe is poised to outperform because it’s reopening more successfully than the United States is running rampant. However, if that narrative was working – with sentiment turning, investors returning, and recent weakening of the US dollar against the euro – we should have seen Europe catching a bid as US virus hotspots have intensified and mobility data has softened. But it hasn’t worked out that way. A nice rally during the cyclical bounce in May / early June driven considerably by euro appreciation has been flat-lined ever since. Europe is an export-driven economy linked to global trade and US growth. It’s arguably a levered play on the US reopen, not a play in its own right.

Have You Heard?
Now back to news of the crowded tech trade. Again, who didn’t already know that tech was popular? Many pundits were calling it a bubble even before the crisis, but it’s only gotten more crowded and could stay crowded for a long time – for good reason. We all know the story: good management teams, strong balance sheets, little debt, lots of cash, reliably stable cash flows, monopolistic characteristics, products that people want – and don’t forget a global public health crisis that increases demand for their products even further. Tech stocks are essentially the last beacon of growth, and the pervasiveness of high-quality companies in the sector has arguably made it the new defensive trade. Just because it’s crowded doesn’t mean it has to collapse.

The Virus and the Tech Trade
The resurgence of virus hotspots in the US has demonstrated the risks of normalizing too much, too fast, and not taking enough precautions (mask mandates, social distancing, etc.). The result is likely to be a bias by state and local governments, corporates, and individuals to be more cautious on the reopen going forward. If we can continue to make progress cooling down these hotspots, the reopen is likely to continue, albeit with fits and starts, but the path back to trend growth will take longer and follow a shallower curve.

So what does that mean for that crowded trade in US tech? A slower recovery means lower growth for longer – lower rates, flatter yield curve. We believe all of that continues to lean in favor of growth and tech over value. What if we’re wrong and the recovery goes smoother than expected? It doesn’t mean growth and tech roll over and decline. In our view, that wouldn’t mean a bubble bursting, it would simply denote a leadership shift. Tech should still largely participate, but underperform the more cyclical sectors.

Think Small?
We very well may be setting up for another surge for cyclicals and small-caps – and yes, potentially even European equities. Investors are underexposed and relative value has gotten back to recent lows. If we start to see some peaking and rolling over of cases in US hotspots, we could see another sharp rotation to recoup some of that underperformance. But if that recovery slope begins to flatten out as we expect, the rotation may run out of steam, and that crowded tech trade will likely remain crowded for quite some time.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed may change based on market and other conditions.

Natixis Distribution, L.P. is a limited purpose broker-dealer and the distributor of various registered investment companies for which advisory services are provided by affiliates of Natixis Investment Managers.

Equity securities are volatile and can decline significantly in response to broad market and economic conditions. ­

Smaller company investments can be more volatile than those of larger companies.

Foreign and emerging market securities may be subject to greater political, economic, environmental, credit, currency and information risks than US securities.

These risks are magnified in emerging markets.­

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