Equity Strategy: Use relief bounces to reduce beta and Value factors further: Growth-Policy tradeoff remains unattractive

Speaker: Mislav Matejka, Head of Global Equity Strategy

 

We stick to our call that Q1 will likely end up the high point for stocks this year. While parts of the market look short term oversold, and there could be potential relief bounces, we advise to use these to sell into. It is unlikely that we will have a fundamental low reached until the Fed is well advanced with rate cuts. We argued three weeks ago that the next trade is likely to go UW Value, and that one should be defensive in portfolio allocation. Fundamentally, this call is predicated on the view that bond yields will be moving lower, in effect marking a double-top for the US 10-year yield at ~4%, along with a likely end of PMI rebound soon, as the impact of past policy tightening starts to take full effect, and the positive offsets, such as the cushion of COVID savings for consumers, erode. March PMIs could still be sequentially higher, continuing the streak from November of an improvement driven by gas price fall and China reopening, but that could be nearing the peak. Money supply trends point to renewed weakness in PMIs in 2H. The yield curve is likely to be proven right, as every single time in the past. Even if one were to believe that yield curve will stop flattening, perhaps as central banks pause, if the Fed were to pass on a hike this week for example, this might not be a helpful sign. After all, the curve would typically begin to steepen just ahead of a recession starting. From the point of maximum curve inversion to the start of recession, the sector leadership would be dominated by low beta bond-proxy defensives, and Banks in particular tended to perform poorly. Central banks could keep their “higher for longer” mantra. Labour markets and inflation continue to be some of the most lagging indicators of the cycle, and as inflation stays elevated, the pain threshold for the Fed might be higher this time around than what investors would hope for – the market could be increasingly pricing in a policy mistake. Banks and Cyclicals performed strongly in the past few quarters, and even post last week’s correction are still elevated. It is not clear that Cyclicals enjoy valuation support vs Defensives anymore, and their earnings will be more sensitive to potential consumer and corporate disappointments ahead.

 

This podcast was recorded on 19 March 2023.

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