Janus Henderson Investors: The big rotation

Key Takeaways

• While consensus opinion is that the global recovery will be anything other than ‘V’-shaped, global stock markets seem to be carving out this very shape.
• Price action suggested the global market rally has been driven by faith in central bank
• liquidity provision, rather than confidence in global growth.
• Investors generally remain defensively positioned in terms of asset allocation and sector exposures. While the rally and the rotation can extend, further gains may require positive news on the economy and the coronavirus.

It has been widely observed in recent weeks how awkwardly the sustained recovery in global investor risk appetite sits alongside the escalating social unrest in the US and the uncertainties overshadowing the global economic outlook. While consensus opinion is that the global economy faces difficult times ahead and the recovery will be anything other than ‘V’-shaped, global stock markets seem to be defiantly carving out this very shape. This is most clearly illustrated by the NASDAQ Composite Index, which is now back at its all-time high and is up 10% year-to-date:

Exhibit 1: The NASDAQ Composite Index has rebounded sharply

Source: Bloomberg, Janus Henderson Investors, as at 4 June 2020. Past performance is not a guide to future performance.

The rally mutates

The frantic rotation in market leadership over the past three weeks (to 8 June 2020) has seen the liquidity-driven rally mutate into a full-on reflation trade. The rally in global markets during the first eight weeks after the March low in global equities suggested markets were being driven by faith in central bank liquidity provision, rather than having much confidence in global growth. Perceived defensive assets such as government bonds and gold rallied alongside risk assets. In the equity markets, secular growth areas, such as technology and pharmaceuticals outperformed value stocks and cyclical sectors.

The last three weeks has also seen a dramatic change in market leadership. Inspired by the reopening of several economies, some better economic data and a continued flow of stimulatory global policy initiatives, investors have pivoted away from the areas of the market that led the first leg of the recovery into the laggards. In just three weeks, Brazilian equities have bounced 43% in US dollar terms^[1] and eurozone equities have rallied 28%. Cyclical sectors such as banks, autos and steel have surged in all the major markets, massively outperforming growth stocks and defensives. While pharmaceutical stocks outperformed banks by 27%^[2] in Europe during the first eight weeks of the market recovery, banks have been the big winner in the past three weeks, outperforming the drug stocks by nearly 30%.

The recovery begins

A few key data points in recent weeks have certainly helped revive some investor confidence in the recovery, albeit from very depressed levels. While there is great uncertainty surrounding the reliability of Friday’s 10 million jobs’ positive surprise in the US payroll data, it is nevertheless yet another key data point suggesting that the global economy is emerging from what could be the worst global slump since the Great Depression. Purchasing managers’ surveys in most major economies have already turned the corner and other high frequency data are also building the case for a mid-year rebound. While we agree with the broad conclusion from consensus forecasts, that it will take two to three years for the global economy to fully recover from the coronavirus, we suspect that investors will put longer-term concerns aside in the weeks ahead and instead focus on the evidence of improving short-term macro momentum, as they have done in recent days.

Of course, confidence in the economic recovery is still entangled with perceptions of how the coronavirus is evolving and is likely to remain sensitive to any changes on this front. Although many important aspects of COVID-19 remain unknown, each day that passes without a resurgence is seen as lowering the likelihood of the most pessimistic projected outcomes. The data in the former hotspots of China, Singapore and South Korea remain encouraging ― flare-ups have been small, localised and quickly contained. In Wuhan, the original epicentre of the pandemic, recent testing of more than 11 million people showed that the virus has almost disappeared there. Against this background, consensus opinion on the coronavirus seems to be shifting away from the dread of a big second wave of infections towards more benign scenarios.

Bad news travels fast

Still, while the spread of the infection is now slowing in most of the major developed countries, the overall global picture is much less encouraging, with total world cases doubling since the start of May, as the virus surges though Africa, Latin America, the Middle East and some parts of Asia. Furthermore, while China’s success in flattening the coronavirus curve was helped by its cautious approach to reopening its economy, the US seems to be emerging from lockdown with the daily increase in numbers of new infections still trending higher in many states. Right now, it is hard to predict what impact the easing of lockdown restrictions in the major economies will have on the virus’ transmission.  We will know a lot more in a few weeks from now. While positive developments on the coronavirus front will probably take some time to corroborate, bad news could come quickly if infection rates rebound as lockdown restrictions are eased.

Glass half full

For now, investors seem to be shifting towards seeing the glass as being half full, where most of the news flow is concerned. Whereas virtually all our preferred indicators of market sentiment and positioning were showing panic and capitulation in March, the sentiment picture is now more mixed. One of the most supportive technical features for the equity market backdrop is the fact that most institutional investors seem to have underestimated the rally. Even though global equities have been rallying for 11 weeks now and are more than 40% above the March lows, investors have not put much fresh money into stocks and still have sizeable cash balances accumulated during the sell-off. More than US$1.2 trillion has poured into US money market funds since March, taking the cash mountain in these assets to over US$5 trillion, well above levels seen during the 2008/09 Global Financial Crisis.

However, after the frantic market movements of the last few days we also see a few developments that raise questions about the sustainability of the recent market surge. One warning sign here from the options market is the recent rise in the amount of call options being bought in US stocks, relative to the number of puts, a ratio that closed last week at an eight-year high. That looks like speculative froth, as does the sharp rise in US retail participation in equities in recent months. Another cautionary indicator is the level of equity market indices relative to analysts’ share price targets, generated from 12-month price share price targets for individual stocks. Last week’s rally took the MSCI World Index (see Exhibit 2) and the major US stock indices to the highest level relative to analyst’ targets since this data began in 2004.

Exhibit 2: Is the recent market surge sustainable?

Source: Bloomberg, Janus Henderson Investors, as at 8 June 2020.
Note:  Calculation shows MSCI World Index divided by Bloomberg consensus analyst 12-month share price targets. Consensus data are forecasts only and are shown for illustrative purposes. Past performance is not a guide to future performance.

Consolidation time

The recent surge in equities and the associated rotation within the market reflect a rapid investor reappraisal of the global outlook, albeit from a very gloomy starting point. While developments on both the economic side and where the virus is concerned have been encouraging in recent weeks, we would be wary of extrapolating these trends too energetically. Economic data in the weeks ahead should support the notion of a mid-year bounce in global growth, but we see many threats to the economic recovery beyond this. Where the coronavirus is concerned, the next few weeks will be very informative, clarifying whether Europe and the US have shifted the virus onto a similar trajectory as China or whether contagion will revive as lockdowns are eased.

Although the last leg of the rally to date has seen some speculative froth emerging, investors generally remain defensively positioned both in terms of their overall asset allocation and their sector exposures. While this would suggest that both the rally and the rotation can extend further, sustained advances require continued support from the news flow on the economy and the coronavirus. The market moves of the last few weeks have priced in a lot of positive developments.  It would be no great surprise to see a period of market consolidation now as investors await decisive news on the coronavirus front to determine the direction of the next big market moves. 


^[1] Ibovespa Brasil Sao Paolo Stock Exchange Index vs Euro Stoxx 50 Index, in local currency, 15 May 2020 to 5 June 2020. Past performance is not a guide to future performance. Prices may rise as well as fall and you may not get back the amount originally invested.

^[2] Bloomberg Pharmaceuticals vs Banks, in euro terms, 15 May 2020 to 5 June 2020.