Gavekal: Take action – it’s a stock picker market

If only one major factor affects stocks, correlations rise and more stocks move at the same time. At points like this, the point is not to pick the best stocks, but to get the ups and downs of this key factor right.

At other times, there are several factors at play that affect different stocks differently. During such periods, the selection of winners is crucial. For most of last year, the US market was macro-dominated as the economic collapse caused by Covid resulted in a surge in stock correlations, meaning stocks moved in unison.

Investors who hit rock bottom last spring made sizeable gains, almost regardless of the stocks they bought. That was then; This year the correlations have dropped sharply. So what you buy is crucial.

The rally in US equity markets last year was driven by (i) a recovery in economic growth, (ii) an easing of monetary policy by the Federal Reserve, and (iii) an improvement in investor sentiment. While the US economic outlook remains decent due to a likely irreversible economic reopening and fiscal stimulus, concerns are increased inflationary pressures that make monetary policy less unalloyed positive.

There are also signs of over-optimism in the US stock market. Analysts’ estimates of earnings growth are far higher than lagging earnings growth, which means Wall Street has already accounted for a profit recovery.

In addition, a leading measure of retail sentiment sits at more than a three-year high, while a similar measure of institutional sentiment darkened last month. Such divergence is usually a bad omen for US stocks.

In short, with two of the three above-mentioned factors supporting US equities starting to wear off, the outlook is no longer clearly bullish. To me, this means that the market is likely to get higher, but with frequent hiccups.

Hence, the more exciting games should be rotations within the stock space. Over the past few months, me and my colleague Will Denyer have highlighted four major shifts, namely (i) Covid winners to losers, (ii) appreciation, (iii) large to small caps, and (iv) a shift towards energy and materials Plays. These rotations have stalled over the past month but should get another run.

Covid winners become losers

This rotation began when the introduction of the vaccine allowed investors to look beyond the pandemic. New Covid outbreaks in states like Michigan are likely behind the recent reversal. However, the likelihood of general restrictions being imposed is relatively small as US policy makers rely on vaccinations to keep infection rates down. Therefore, the rotation from Covid winners to losers should ultimately be resumed.

Growth to value stocks

The weaker performance of value stocks corresponds to an apparent stabilization in US bond yields. This can be explained by the fact that US citizens used some of their incentives to buy government bonds, while higher yields led European and Japanese investors to buy US bonds currency-hedged. However, such a situation is likely to prove temporary for a number of reasons.

The U.S. Treasury Department is likely to cease being a net funder when it hits its target cash balance of $ 500 billion (£ 360 billion) in the second quarter (about $ 420 billion remaining). Higher US imports and faster adoption of vaccines in Europe could support growth outside the US in the second half of the year. In this case, the yields of non-US bonds can rise and make government bonds less attractive.

In the longer term, stronger US growth and inflation should boost both US bond yields and value stocks. And since US shorts should stay at zero for a while, that situation is likely to revive the rotation from large to small cap stocks as well.

Energy and materials

US demand for raw materials is likely to remain strong as the government gives cash to consumers while domestic production lags. As US manufacturing picks up to meet demand, commodity producers should thrive. With the Democrats likely to pass their grand infrastructure spending plan, rebuilding roads and bridges in the US will also increase the demand for raw materials

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Gavekal: Take action – it’s a stock picker market

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