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Macquarie Wealth Management: 28 May 2020 Research - Breathing life in value stocks – equity rotation just getting started

Macquarie Wealth Management - Quick Comment01

  • We are encouraged rather than discouraged by the sharp value stock rotation that is underway. Durable rallies have broad leadership, and this requires those stocks/sectors which had been left for dead showing some signs of life.
  • Equities have rallied hard in recent weeks, but we think the drivers behind this strength have not been exhausted. The two major macro tailwinds – monetary and fiscal policy – remain strong and confidence around the reopening of economies is picking up. In addition, sentiment is not extended.
  • There are a lot of risks that could periodically upset the current trend. But we don’t think these are strong enough to step back from the market. Our view that equities will be meaningfully higher in 9-12 months is unchanged. Remain alert but don’t fight the tape.

Equity markets have been on a tear with positive momentum picking up substantially in recent days. We turned more constructive on equities in early April and have continued to push back on concerns that the rally was a bear market bounce, that risk assets were becoming overly disconnected with fundamentals or that valuations would be a short term constraint.

We are encouraged rather than discouraged by recent equity market strength / value stock rotation and maintain our view that equities will be meaningfully higher on a 9-12-month basis. At this stage, we do not think the fuel for the equity market rally is near being exhausted and we believe a broadening in leadership is a positive sign.

Macquarie Wealth Management - Breathing Life - Chart01

In recent days, global equity markets have been buoyed by a strong rebound in cyclical sectors as well as some of the value laggards (financials and real estate). We believe this is a healthy development and reflects stronger conviction in an economic recovery as well as optimism around the reopening of economies and a coronavirus vaccine. Up until a week ago, equity market leadership was being dominated by valuation expansion in structural growth stocks and high-quality cyclicals such as technology and (relative) beneficiaries of lock-down.

This is not too dissimilar to the traditional playbook where money flows into the higher quality, but not necessarily defensive, stocks at market turning points. In line with this, the second phase of a recovery cycle is generally when lower quality cyclicals join the rally. In this case, it is stocks and sectors which may have been held back by COVID-19 concerns (such as retail and travel & tourism) and for the most part financials.

Macquarie Wealth Management - Breathing Life - Chart02

We think it is premature to be scared off by the equity rally or to be aggressively profit taking when signs of life are emerging in economies opening up. The two major macro tailwinds – easy monetary conditions and loose fiscal policy – also remain intact. At some stage, the handoff from easy policy towards a self-sustaining economy will need to take place. We think markets should fear a policy mistake that could involve the premature removal of fiscal support rather than the market being tripped up by its own bullishness.

Macquarie Wealth Management - Breathing Life - Chart03

Similarly, sentiment is not euphoric and points towards further inflows as conviction in the recovery deepens into those either sitting on the fence or those positioned for a second wave. To date our preference has remained with high quality growth stocks and cyclicals with little balance sheet risk. We have not been chasing deep value cyclicals which are earnings recovery plays simply on the basis that significant “main” street pain is yet to play out.

Macquarie Wealth Management - Breathing Life - Chart04

The market has jumped the gun on this with the aggressive rally in banks, REIT’s and selected hospitality stocks in recent days. We don’t think investors should be making a major adjustment to the quality of their portfolios by fully rotating out of growth stocks and into value, but clearly if recovery is now more certain (Macquarie has been talking a faster reopening for some time now), then value and financials are likely to remain better supported. We think stocks that offer valuation upside rather than betting on an earnings recovery is a safer way of adding beta while still controlling for potential earnings disappointment.

Our overall message is that the rally, while vulnerable to disappointment, still has its major drivers intact. We worry about rising political risks, 2nd wave impacts, a host of equity specific risks and that markets are running at a pace that cannot continue…but just not enough to step back from markets until we start to see the tailwinds fade or sentiment turn significantly more bullish.

Jason and the Investment Strategy Team


The report was finalised on 28 May 2020
Recommendation definitions (Macquarie Australia/New Zealand)
Outperform – return >3% in excess of benchmark return
Neutral – return within 3% of benchmark return
Underperform – return >3% below benchmark return
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