Supportive and predictable policy helping keep equity volatility low
Major equity indices globally have been remarkably stable in recent months, pushing realized volatility readings to very low levels.
Our own research along with that of many others has shown that volatility in equities tends to be persistent in the shorter-term, while tending to mean-revert in the long-term.
Beyond the movements of a single index like the MSCI ACWI or S&P 500, we can also see that the average three-month volatility across a broad array of major developed markets individually is extremely low (chart below). This average of 18 countries’ volatility (based on their respective MSCI country equity benchmark index) is in the bottom decile of its 10-year range right now. This means that it is not just the dominant US market that has had low volatility, nor is it only the diversification effects that can dampen volatility in a broad global index, it is in fact a global pattern of low equity market volatility across many markets.
Market volatility vs Style volatility
Equity market volatility has been declining this year and has recently been below the long-run average. However, under the surface of the calm at the major index level, style rotation between Growth and Value has been extremely high.
The first chart below plots two rolling volatility series: the top section is the six-month annualized volatility of the S&P 500 index, while the bottom section is the volatility of the daily difference between the S&P 500 Pure Growth and Pure Value index returns. The dashed horizontal lines indicate the long-run average for each series.
Growth rebound looks extended, as do long-term bonds
We have heard a number of client questions about the recent rebound in Growth stocks relative to Value (or Cyclical) stocks, so here we review some of the recent price action and one of the key cross-asset drivers.
The first chart below plots the relative performance of the S&P 500 Pure Growth versus Pure Value indices (top section) along with the 14-day RSI technical indicator (bottom section) as a measure of overbought/oversold conditions.
Analyst uncertainty still high even as earnings estimates surge
As we have discussed for some time now, equity analysts are raising their forecasts for corporate earnings more broadly and by larger amounts than at any previous time in our 20-year data history. However, while analysts are confident earnings are rising, they still show significant uncertainty about the future level of earnings, as reflected in the dispersion or disagreement in estimates for US companies.
Cyclical sectors still have the fundamental momentum
One of the biggest questions we have been getting from clients is “is it time to rotate out of Cyclical/Value sectors toward Growth (or Defensive) sectors?”. Based on our measures of fundamental earnings momentum and macro views, our answer is “not yet”.
There has certainly been rotation in relative returns among Cyclical/Value and Growth sectors recently, along with worries about when the Fed or fiscal policy will shift to a less supportive stance. Our view is that corrections or consolidations after large gains (on an absolute or relative basis) are healthy and to be expected, and that is likely what we are seeing in the Value/Growth relative performance recently.
Sector Pair: Financials vs Health Care
In recent months, two of our strongest US sector allocation views have been to overweight Financials and underweight Health Care. A key feature of our sector work is that we often look at sector indicators on a “pairs” basis, i.e., the relative return, earnings momentum, and valuation of one sector versus another (as opposed to comparing sectors only to an overall benchmark like the S&P 500). This allows us to see the underlying relative performance drivers more clearly.
Inflation trend is still low
One of the biggest topics among investors recently has been inflation, particularly after the May Consumer Price Index (CPI) and Producer Price Index (PPI) reports (reflecting April data) that showed big monthly jumps in headline inflation: 0.8% for headline CPI and 0.6% for headline PPI. And the “core” rates that exclude food and energy were actually slightly higher than the headline rates in April.
Analysts raising estimates at a record pace, again
While we have commented on the strength in US earnings estimate revisions activity recently, the latest readings warrant additional comment. Our data now show a new record (20-year+) high in the net proportion of analysts raising earnings estimates for US companies. The latest reading exceeds the recent then-record high seen at the start of this year, as shown in the chart below.
Commercial Real Estate finally on the rebound?
Among the biggest losers from COVID-19 and the resulting work-from-home trends that followed was the commercial real estate industry. Office buildings and retail stores that had been mostly full in 2019 were suddenly empty, and the companies that had been renting the space were often unable or unwilling to continue paying. And while stimulus support has helped much of the economy, the impact on commercial real estate has been more limited.
Rotation, not risk-off
In response to client questions, we update some indicators we discussed back in January to address the debate about whether recent market action is indicative of a defensive shift (potential equity market top) or a rotation within equities that maintains a “risk-on” environment. Our current view, as it was in January, is that risk appetite remains broadly intact and the weight of the evidence suggests that we are seeing a rotation, not a “risk-off” environment.