Reasons for market optimism remain despite slowing global growth and persistent geopolitical tensions, as investors’ pivot into riskier areas like emerging-market ETFs and bank stocks attests.
But with caution still ruling the day, trading strategies are increasingly focused on how to turn pockets of market weakness to their advantage — arguably a sign of a resurgent emphasis on value in investing.
Bulls on Parade
The case for bullishness starts on technical turf. The S&P 500 hasn't fallen 1% or more in two months — 2019’s longest such interlude — and volatility remains muted, with the VIX falling 6.2% to close at 13.62 Friday. Historically, December has been the best month of the year for the DJIA, S&P 500, and Russell 2000 indices.
In fundamental terms, though, trade hopes are the cornerstone buttressing market optimism. In early November, traders began eschewing European low-vol shares in favor of risk-on bets like value and cyclicals as hopes for a growth-spurring US-China trade deal surged.
Defensive bets started looking increasingly crowded, and investors plowed more than $1B into emerging-market ETFs in one week — the biggest inflow in nearly a year.
That optimism has expanded into equities more generally of late despite mounting US-China tensions as US stock funds saw their biggest inflows in three months ($5B) for the week ended December 4. A Barclays survey found a majority of investors expect an upside surprise in global growth in 2020, fueled by growth in the Eurozone and emerging markets ex-China.
Investors are also optimistic Thursday’s UK elections will produce a Conservative majority — a market-friendly outcome that has coaxed the pound up 9% from mid-August lows and seen short bets against sterling gradually unwind despite continued Brexit uncertainty.
Collectively, the developments reflect investors’ hope that the worst of the global growth slowdown has passed as central bank policy making returns to friendly footing, a potential trade deal augurs economic tailwinds, and US consumer data remains strong.
Even so, markets continue to tilt bearish. Investors are assigning a 79% probability to interest rates remaining unchanged by the Fed's March 2020 meeting and 21% odds of a cut. The eight-week moving average of bullishness among individual investors has slid from 50% in early 2018 to 36% last week.
Behind that anxiety lay growing odds of a recession in the next twelve months, which have more than doubled from 10% at the start of 2019 to 21% but remain in check for now. They are, however, forecast to peak at 38% in October 2020.
Amid continued economic uncertainty, investors have exited stock funds in droves this year. They’ve yanked $135.5B from US stock-focused mutual funds even as markets head for their best year (+25%) since 2013. By contrast, investors have poured money into bond funds (+$277B) and money-market funds (+$483B) as they pare risk.
Corporate stock buybacks, which have propped up markets in recent years and are expected to total a whopping $480B this year, could also taper off going forward, exposing markets to a downturn.
That means traders are hunting pockets of profitability in markets both uneven and uncertain — arguably a driver of a nascent value-investing revival.
In fixed income, hedge fund CQS recently emphasized that Brexit uncertainty is creating value-investing opportunities in distressed UK companies for firms willing to hold onto investments through a downturn.
Barclays meanwhile suggested more than a month ago that “‘it may be time for a little bottom fishing’” on battered Hong Kong stocks — counsel that carries added weight following massive protests in the city yesterday.
Those strategies dovetail with the finding that value stocks perform better as the yield curve steepens — a correlation that has strengthened since 2016. Since inverting earlier this year, the now-infamous yield curve has begun to steepen — a trend experts believe could continue in 2020.
Such dynamics could propel value investing to a resurgence after a decade of struggles relative to growth investing. They could also give investors a way to hedge their uncertainty over markets’ near-term direction.