Investors were able to enjoy their summer holiday this year without losing too much sleep. Of course, that wasn’t to say that nothing has happened on the markets. In fact, we see some interesting developments that have created the opportunity to add some notable underperformers of the past few years to the portfolio.
In contrast to previous years, the markets have been sailing in calmer waters this summer. Last July, ECB president Mario Draghi was making waves with his now famous “whatever it takes” speech to stave off the growing euro crisis. Since then, equity and bond markets have been characterised by a period of relative calm and strong performances. In May, Fed president Bernanke threatened to throw a spanner in the works after announcing that the central bank would start to wind down its highly accommodative monetary policy in the short term. In the wake of some reassuring words from central bankers and growing evidence of a recovery in the developed economies, the panic died down and markets entered smoother waters. Thanks to strong economic figures and pledges by central banks to keep interest rates “low for longer”, the market outlook for the coming months looks favourable.
Equity markets are showing the most promising prospects. Following the “search for yield” in all corners of the financial markets that has been so typical of the past few years – and which led to a huge increase in investor interest for bonds – investors are climbing ever higher on the risk curve. More and more, (institutional) investors are setting their sights on stocks, especially now that the economic figures for the developed economies are clearly improving. This is strikingly demonstrated by the fact that flows to equity funds have now surpassed those in the direction of bond funds for the first time since 2007 and this is a trend which has continued with even greater intensity over the last few weeks. The inflow in bond funds is only moderate and – not coincidentally – concentrated in high yield: bonds with marked equity-like characteristics.
In an environment of accelerating economic growth, cyclical stocks thrive best. While sectors such as consumer discretionary and industrials have been performing well for some time, it now looks as though commodities and related stocks are making a comeback, too. Commodities have lagged behind substantially during the search-for-yield period, given the fact they earn you no ‘carry’. A prolonged recovery in the global economy and especially the better than expected figures reported for China in July provide support. Year-to-date, the materials sector has underperformed the MSCI World by almost 20% and is, with the exception of utilities, the most unloved sector among investors. The sector can expect a strong upturn in earnings growth thanks to the improved prospects for the global economy.
As far as the regions are concerned, things are starting to look up for Europe. For obvious reasons, European shares have been unloved in the past years. This has resulted in a discount of around 35% compared with US equities, which now occupy the largest overweight position in the portfolios of institutional investors in 10 years. Now that European economic data are clearly improving – and the eurozone is showing growth again for the first time in six quarters – the tide seems to be turning for European equities. Investors have put the systemic risk of the eurozone onto the back burner, while the recovery of the European economy is being bolstered by persistently accommodative monetary policy, a declining fiscal drag and an increase in global growth.
The day has now dawned that investors are shifting their faith from yield to value in the market. In the first instance, this will favour equities. At a subordinate level, those regions and sectors which have clearly underperformed over the last few years are making a comeback. Revenge of the nerds!
Valentijn van Nieuwenhuijzen is head of strategy at ING Investment Management
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