Richard Buxton: What's Going On?
Whilst the FTSE100 continues to flirt with multi-year highs, like the proverbial swan serenely moving on the water, the quite savage sector and size rotation we have seen in recent months masks furious paddling activity below the surface. After two years in which the average active manager has soundly trounced the index, the index is now whipping the actives and is firmly positioned within the top quartile. The midcap index has fallen 8% since the end of February, whilst the FTSE All-Share Index is barely unchanged, indicating the degree of rotation away from mid and small cap stocks to the previously unloved mega-cap stocks.
What is driving this – is it a temporary rotation or the start of something more profound and long-lasting? In fairness, the valuation stretch between the mega-cap stocks and the rest of the market had reached levels by the end of 2013 from which there was always likely to be some snap-back. The catalyst within the market seemed to be the bursting of the hot momentum sectors – notably tech and biotech in the US, alongside some highly questionably priced IPOs here in London.
The bursting of this bubble quickly spread to a ‘take profits’ mentality in anything which had performed strongly in recent years, which inevitably meant many mid and small cap stocks, domestically-sensitive and cyclical shares. Add to the mix the speed of the share price moves, forced cutting of leverage in clearly popular crowded trades, the corresponding unwinding of short positions in large caps and emerging market-related stocks and the consequences have been all too clear.
Is this purely a market and investor positioning issue, or is it reflective of deeper economic concerns? Contrary to expectations at the start of the year, bond yields have fallen to levels suggesting that global growth is likely to disappoint. Whilst data from China has remained weak, the US does appear to be shrugging off the effects of winter and job growth remains positive. The UK is clearly in a strong recovery phase, although the European Central Bank is flagging the need for more stimulus in Europe. Is the bond market telling us that in ‘the new normal’, the ‘lowflation world’, low nominal growth will prevent central banks from even beginning to take interest rates up from their emergency low levels?
Without doubt, the post-financial crisis healing process is not over yet. But with the levels of economic growth likely to be delivered this year and next in the US and UK, it is difficult to believe that the bond market is really signalling that activity has peaked and is rolling over, nor that corporate profits will fall from here. Corporate confidence is improving, as witnessed by improved hiring, rising job vacancies and higher levels of M&A activity.
More likely current market moves reflect prior investor positioning and sentiment. Trouble was expected in the bond market this year as US Federal Reserve tapering continued – instead the impact has been felt in crowded and illiquid equity positions. The shake-out is testing those, like myself, of a generally benign and bullish outlook, as bull markets always ‘climb the wall of worry’. It is creating opportunities to add to favoured holdings at attractive levels. It rightly forces you to re-examine your views and convictions, but I remain of the view that this is more of an internal market and positioning issue than anything more sinister.
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