Market Thinking

making sense of the narrative


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Short term Uncertainty and Medium Term Risks

While we continue to puzzle over official pronouncements on the pandemic, markets are nevertheless thinking about growth, inflation and asset allocation. One of the issues challenging asset allocators in particular at the moment is whether or not there has been a strategic rather than just a tactical shift in Value versus Momentum.

The chart shows two of the Global ETFs that we monitor and trade in our Factor Model Portfolios and we can see how that recently Global Value as a strategy has started to claw back some of its (dramatic) under-performance over the last few years versus Global Momentum. Indeed it looks like we can see a reversal of the first six months of the Pandemic – which basically boosted working from home (WFH) tech momentum stocks over IRL (In Real Life) value stocks such as those associated with Commodities.

There is a good background article on the subject as well as factor investing from the FT here .

Chart 1: IRL v WFH – Global Value v Global Momentum

Source Bloomberg, Market Thinking

Our own approach is to have a basket of these smart Beta strategies (global factors) and rebalance between them according to our own assessment of the risk/return structure. As such, for us it is not an either/or structure and we don’t have to make this big directional call at the moment. But if we are looking at more ‘traditional’ ways of structuring portfolios based around geographic or sector groupings then the apparent resurgence or otherwise of ‘value’ involves active decisions on, amongst others, Banks, energy and basic materials.

A traditional geographic or sector based approach is wondering on the need for rotation to avoid benchmark under-performance

This in turn ends to loop back around to the macro, where currently the glass is definitely half full, with data on US unemployment and the prices paid component of the Purchasing Managers Index (PMI) being used to support further ‘reflation/inflation trades’. Certainly we were able to observe how more cyclical stocks – which tend to get bracketed as ‘value’ when they are out of fashion,as was the case in q4 2020 – have run strongly, first in q4 and then in the second half of q1 2021, but there is a fundamental difference between a tactical rotation relative to a benchmark – essentially being underweight and having bought back so as not to under-perform – and a strategic shift. The former rather than the latter looks to have been he key driver in March and the fact that it has now reversed somewhat tends to back this up.

In the meantime for there is a bit of confusion to the whole subject in that some ‘value stocks’ – so determined on account of their fundamentals – have also become ‘momentum stocks’, so called on account of their recent price action! The narrative of course remains that there has indeed been a shift and it is about inflation, but while commodity related stocks have certainly run hard, the commodities themselves have kept going while the stocks have paused which makes us wonder if the traders are now all back in the Commodity and FX space. In short, was this all a noise trader narrative, or is there actually something more permanent happening?

Longer Term Trends

Having conceded that for our own portfolios we don’t necessarily have to jump to a conclusion – our systems are already tilting to value and have been for a while – it does seem to us that when we consider longer term themes that there has indeed been a Strategic shift and that it is one associated not with inflation per se, but with pricing power. The Quants will likely frame things in terms of a strategic shift in expectations on discount rates affecting the value of short duration versus long duration assets (something we touched on in our March Market Thinking) but more simply, the shift we are seeing to ‘government as buyer’ of goods and services offers the scope for margin expansion and super-normal profit for some, while the shift to government as, if not seller then regulator, suggests margin pressure for some others. Just as we used to refer to ‘The China Price’ – everything China makes more of goes down in price, everything they buy more of goes up in price – so governments and their Magic Money Tree are setting The Government Price’. It is almost certain that none of this will have yet been factored into the medium term earnings expectations for either group. Thus some value stocks will now have the opportunity to sustain excess profits for a longer period – think of the 2009-2012 China commodity boom – while some growth stocks that currently show up in momentum indices could find their regulatory moat taken away, or worse.

To conclude, Value versus Momentum is something of a curious argument for macro traders and investors in so far as a basket of ‘Value’ stocks or Momentum stocks are likely to have more things not in common than in common. A basket can be cheap or showing strong momentum for multiple stock or sector specific reasons and unless those are all correlated and all reversing, then it is difficult to understand why the basket as a whole should move on any individual shifts – except that is in the short term. We suspect then that this is a combination of short term trader narrative on inflation/reflation trade being combined with classic rebalancing behaviour by asset allocators towards ‘cyclical value’ areas. As such it may well be over for now, but the longer term themes of pricing power remain central for investors.

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