Last month’s commentary stated that “we now view markets as being expensive, with an increasingly asymmetrical risk/reward outlook when peering out over the next 12 months”. The S&P 500 had been trading comfortably north of 20X forward EPS amidst signs that monetary accommodation had peaked and a material retrenchment in fiscal stimulus was forthcoming. Our investment team proceeded to tactically reduce the net exposure of each of our two funds, resulting in solid net gains for the month of September.
While the deck of cards that market participants base their investment decisions upon has remained constant since COVID-19 changed the global dynamic 18 months ago, continued reshuffling of that deck has catalyzed significant month-to-month volatility across asset classes, equity sectors and factors. Unprecedented levels of liquidity remains the dominant variable pushing equity indices higher, yet larger-than-expected rates of deceleration in the American and Chinese economies (please see graph below), combined with fears surrounding the Delta variant, caused the growth style of investing to continue to outperform value during August.
Led by macro cap technology stocks and long-term government bonds, financial markets added to their year-to-date gains during July 2021 amidst growing concerns that, not only has the rate of acceleration in economic growth peaked, but it is transitioning to markedly slower levels. This note will table some thoughts germane to that discussion, but first let’s recap last month. As can be seen from the 18-month graph below, the strong correlation between falling yields and the outperformance of the tech-dominant NASDAQ has continued of late.
When we published our 2021 Market Lookahead commentary (December Commentary) in early January, it was an easy call to be bullish on stocks. The pitch was simple and the majority of buy and sell-siders shared similar outlooks. Unprecedented stimulus, albeit higher but still low interest rates and an expected flow of funds into stocks partially supported by declining volatility. With the S&P 500 having closed last week at 4,352 the outlook call gets tougher for long-only managers and especially sell-side equity strategists who have a propensity to be bullish. Interest rates remain surprisingly low and, as can be seen from the right side of the first graph, declining volatility (yellow line) continues to boost the capital allocation to stocks (white line) for traders targeting portfolio volatility of 10%.