Tilting toward Growth over Value
One of the themes in our sector/style work recently has been to tilt somewhat more toward Growth over Value and Cyclical areas within the US market.
Why? Three key factors support Growth over Value, while one remains a concern.
Our bottom-up aggregated earnings estimate revisions trends continue to favor Growth
The relative performance trend has been shifting back to Growth over Value
However . . . relative valuation of Growth versus Value remains stretched versus historical norms, though the interest rate backdrop is arguably a structural reason for that
Also, the relative risk (volatility) differential of Growth vs Value has moved back in favor of Growth (i.e., Growth is now less volatile than Value on a rolling six-month basis).
Time to take profits in Financials?
As Q3 earnings season gets underway, stocks in the Financials sector are in focus as they are typically among the first to report earnings. While history indicates companies are on average likely to beat Q3 estimates, our indicators, which have been supportive for Financials all year, are now starting to weaken and suggest it might be time to take profits in the sector and reallocate to other areas.
Emerging Markets fundamental momentum still very weak
In our regional allocation work, we have been underweight in Emerging Markets relative to developed markets since May, and remain so currently. A key reason for our continued underweight stance is that the relative fundamental momentum for emerging markets remains very weak compared to that of the broader global equity market.
The chart below shows one of our popular composite indicator charts based on the relative performance of the widely-followed MSCI Emerging Markets ETF, ticker EEM, versus the broad global benchmark of the MSCI All-Country World Index (ACWI) ETF, represented by ticker ACWI.
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.
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.
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.
Cyclical sectors still dominating globally on earnings trends
As we discussed in our last commentary, analysts continue to raise earnings estimates broadly as companies keep beating consensus expectations. Expectations of additional fiscal spending and ongoing easy monetary policy along with progress toward re-opening of the economy are key macro drivers, while certain sectors such as Energy and Financials which had been areas of weakness in pre-COVID and immediate post-COVID times are now contributing more positively to the earnings outlook. This is true in the US and also globally.
Tech Sector In The Driver’s Seat For US Relative Performance
In this post, we highlight the interaction of US outperformance versus the rest of the world this year and US Technology relative to Ex-US Technology.
First, the relative performance of the US equity market versus the rest of the world has been highly correlated with the relative performance of US Technology stocks relative to Ex-US Technology stocks.
Second, the outperformance of US Technology, and by extension the major US indices versus their non-US counterparts, looks likely to continue based on relative earnings estimate revisions patterns.
Is the rebound in earnings estimate revisions peaking?
Our measures of aggregated earnings estimate revisions trends have shown some of their most dramatic movements on record this year, and now may be looking extended.
After reaching historically extreme negative readings in April/May amid the initial COVID-19 lockdowns, earnings estimate revisions activity has now lurched back up to extremely positive readings. Better-than-expected Q2 earnings reports and the effects of massive monetary and fiscal stimulus are now finally reflected in analyst earnings forecasts. However, with fiscal stimulus weakening (and little imminent sign of movement toward new stimulus) and no meaningful further scope for interest rate cuts, the “snap-back” in earnings estimate activity could soon drop off.