Much has been written, including by us, on the growth/value dynamic within equity markets. However, current extreme market divergences aren’t confined to these two styles or indeed just to equities, though they are very much related to a single and unique environment.
This historically unusual environment has been created by a number of extraordinary forces combining. Primarily, an extended period of unprecedented monetary policy, the drive for renewable energy and technological innovation. The latter is not unusual per se, in fact it punctuates economic history, but the internet and internet related innovations are a relatively recent phenomenon and are an important driver of the current investment environment.
These three forces, long term in nature, originate from unrelated sources but reinforce each other in many ways. For example, low rates help tech start-ups, while technological innovations have helped facilitate game-changing progress in the sphere of renewable energy and the disinflationary impact of technology has helped keep rates low. An example of what this has meant for financial markets can be seen in the graph below where, in the space of a year, the clean energy index has almost doubled, while the oil index has almost halved.
New economy winning over old economy: S&P global clean energy outperforms global oils
Source: Bloomberg, 21.10.2019 – 19.10.2020
There are of course other forces, such as the impact of Covid-related lockdowns, that help compound this environment in the shorter term, for example, by adding to disinflationary pressures. Ironically, it might be these very same lockdowns that in the longer term lead to reflationary pressures, in the form of a significant US fiscal package which might well have a green infrastructure dimension, reinforcing one of three pillars of the current environment (renewables) but eroding another (the low rate environment).
In the meantime, as mentioned above, the impact of this unique environment is not limited to equity. Sovereign bond yields remain close to record lows, limiting their impact as a safe haven in portfolios, as, in order to balance equity risk in portfolios, so much duration is needed that it ends up producing a significant duration risk. Cash, meanwhile, is no longer perceived as an asset class by many, as it is zero yielding, though in absolute terms it clearly retains some safe haven attractions, especially as government bonds are somewhat compromised.
Indeed, a cascade of implications across sub asset classes can be seen: a general preference for growth over value, overseas over UK (old economy), developed over emerging (similar to growth over value), credit over government bonds (yield compression), gold over US Treasuries (yield compression) and cash over sovereign bonds (duration risk).
Investors approach these divergences in different ways. Some value investors rub their hands and are happy to wait for some value to be realised, “fundamentalists” roll their eyes and decry the madness of the situation, while pragmatists, like us, get behind those persistent trends in financial markets, where there is some evidential support.
That said, there are of course risks. A key risk is a more reflationary environment, which might see yields and inflation pick up and value start to outperform growth. Triggers for this might be a vaccine or a significant US fiscal package or, just as likely, the triggers might not be so obvious. Timing any switch is crucial: just observing that a piece of elastic is tight, provides little insight into when it might snap back. Furthermore, the elastic has been tight for quite a few years now.
Anthony Rayner, Premier Miton Macro Thematic Multi-Asset Team, 20.10.2020.
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