Liquidity and momentum shroud the rotation debate

Date published: 07 January 2020

Michael Mackenzie

Liquidity and momentum are powerful drivers of sentiment for equities and other risk assets. Such a combination holds sway at present, via supportive central banks and low government bond yields, helping to explain the resilience of markets whenever shocks such as the latest bout of political tension intrude.


Here, via Longview Economics, you can see the importance of what its analysts call “central bank largesse”. Beyond a cautious tone near term, they argue “the outlook for the S&P 500 over the 1st half of 2020 is positive” as “the case for the US economy continuing its mini cycle reacceleration remains in place”.

Jack Ablin, chief investment officer at Cresset Asset Management, says that among the five equity market “traffic signals” he follows, those of liquidity and positive momentum stand out, and this combination “suggests US equities will continue to grind higher”. But with the economy flashing yellow and valuations showing a vermilion hue, there are grounds for a correction — or, as Jack adds:

“Near-term risks include geopolitical issues, trade uncertainties and the 2020 election season. For now, stick with your current equity exposure. However, new money should remain patient.”

Putting new money into US equities is a tough call when the broad market sits just shy of record territory and is coming off a strong decade of returns. That naturally arouses concerns about Wall Street maintaining such a pace as the 2020s unfold, and why many advocate looking at equities elsewhere, which have been left behind by the S&P 500 over the past decade.

Still, some think betting against Wall Street is premature.

State Street Global Markets highlights how earnings have been a principal driver of US equity performance over the past decade via this chart. It shows how information technology and consumer discretionary groups within the S&P 500 have generated a return in the region of 400 per cent over the past decade, but these are also sectors (alongside communication services) that have lead the way in generating earnings.

State Street adds:

“While we start the new decade with US equity multiples only a little higher than where we started the 2010s — meaning slower earnings growth could temper further equity gains — our view is that should the US, and specifically the US technology sector, maintain their earnings dominance, the US equity party will continue well into 2020.”

More broadly, analysts at Société Générale focus on the prospect of a US profit squeeze in 2020 via wage costs. They caution:

“Given limited scope for fiscal support due to this year being an election year, US corporate profit margins are all the more under scrutiny. With labour productivity continuing to rise at a sub-average rate of around 1.7% and wage growth gradually picking up, unit labour cost growth has jumped to its highest pace in five years.”

SocGen believes further earnings pressure looms for US growth stocks, while the bank also warns that . . . 

“ . . . ahead of the next US presidential election, we believe the special status of US ‘Big Tech’ will be questioned. Another way to leverage this view is Long ‘Old Tech’ (Microsoft, Intel and Apple) versus ‘New Tech’ (Amazon, Alphabet and Facebook).”

In turn, SocGen is not alone in looking beyond the US to emerging markets over the coming year. Here are its three reasons for owning EM equities versus the Nasdaq 100:

“A more mature EM equity market, the diversification benefit in a multi-asset portfolio, and a better outlook for EM equities than for US tech.”

A key aspect of backing non-US share exposure in portfolios is the expectation of firmer global activity that rewards sectors reliant upon a perkier economic pulse.

That’s certainly the view from UBS Asset Management:

“After a sustained period of underperformance we currently favour the pro-cyclical and more attractively valued equity markets of the eurozone, China, Japan and emerging markets over more expensive and ‘growth’-oriented US equities, as global manufacturing rebounds and China’s policy stimulus cushions its slowdown. Recent macroeconomic data suggest the global economy is laying the groundwork for a rebound in the first half of 2020.”

Of note is how MSCI’s EM share index topped the S&P 500 during the final quarter of 2019 (11.4 per cent versus 8.5 per cent). That chimes with balance-sheet expansions from the Federal Reserve and the European Central Bank, alongside a weaker US dollar and a firmer renminbi from early-October — a combination that’s typically supportive for EMs.

A counter view comes from DataTrek’s Nick Colas. He argues that should the research group’s basic thesis of 2020 fitting “a late-cycle template” ensue, then “growth stocks will outperform value names” based on the rationale that “markets move on earnings/cash flow surprises and those are more likely to come in areas where revenue growth is reaccelerating after a flat 2019”.

DataTrek argues revenue and earnings growth for the S&P 500 should expand 5 per cent in 2020. For context, it highlights “single-digit earnings growth is better than 2019’s 0.3 per cent”.

With Wall Street enjoying a hefty weighting of tech names relative to global rivals, earnings prowess from that sector likely nudges it ahead of the EM index. Notwithstanding plenty of tech exposure at around one-quarter of its weighting, the MSCI EM index also contains a 22 per cent slice of financials, and that’s some anchor as few expect better news from that group in 2020.


Link To

Copyright The Financial Times Limited 2020

© 2020 The Financial Times Ltd. All rights reserved. Please do not copy and paste FT articles and redistribute by email or post to the web.