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Hype abated, but the cycle is yet to run its course

By Jacob Mitchell, lead portfolio manager of the Antipodes Global Fund – UCITS, and CIO of Antipodes Partners

When it comes to market sentiment, a quarter can make a world of difference.

Much hype surrounded value during the first quarter of 2021. Now, throughout the second quarter, we’ve seen index leadership narrow and multiple dispersion once again approach dot-com bubble extremes.

But from the outset, we note the market rotation into value earlier this year was led by the worst-performing sectors of 2020 – those sold down as COVID-19 shocked markets, as well as US equities.

Despite the hype, we believe investors have only seen the first phase of an ongoing rotation in market leadership. This early stage is driven by normalising inflation rather than expectations around economic growth.

Towards investment-led growth 

Despite the recent consolidation in cyclicals, we don’t think the cycle has run its course. Initially, it can extend in response to the amount of fiscal stimulus we’ve seen and the strength of household balance sheets. The US household has never been in a stronger position to consume above trend.

Negative real yields are at odds with the health of the global economy, and a normalisation in real yields will fuel the rotation in equity preferences. Higher yields force investors to reassess the price they are prepared to pay for growth – they will act as a headwind for weak and overvalued growth stocks.

The rotation can then gather further momentum with new investment cycles.

Central banks don’t want to keep expanding their balance sheets at the same pace, and the pandemic itself has changed policy makers’ attitudes toward fiscal spending. There will be a reluctance to move to austerity too quickly.

Investment programs focussing on decarbonisation, infrastructure, 5G and catch-up investment in healthcare will continue to attract government attention. This, coupled with an unbundling of global supply chains thanks to COVID-exposed vulnerabilities and geopolitical tensions, can unleash a sustainable investment cycle – something that’s been missing from the West as capital spending moved to China over the past few decades.

New market leaders will emerge from this investment-led growth, and new investment cycles lead to a more permanent shift away from a perceived low growth, low-rate environment.

Key risks for equity investors today

US equities have never been more expensive in the last 25 years, both in a relative and absolute sense.

Overexposure to the US leaves investors vulnerable, particularly if the US job market doesn’t fully normalise by the time stimulus expires in September. Excess household savings could remain unspent, and consumption could slow. Critically, this would unfold against a backdrop of higher inflation – we don’t see US core inflation peaking until the end of next year.

The risk is the economy slows materially before the investment-led recovery gains traction. A significant slowdown in activity against a backdrop of higher inflation is a nightmare scenario for US equities in particular, given elevated starting valuations.

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