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Revenge of the laggards as markets finally switch

Banks, resource stocks and small caps led every market recovery in the past … will they do it again?

Maybe the simplest way to put a rocket under the Big Portfolio Switch in global equity markets is through the successful development of a vaccine that allows humanity to revert to life as we all knew it pre-2020. Picture: AFP
Maybe the simplest way to put a rocket under the Big Portfolio Switch in global equity markets is through the successful development of a vaccine that allows humanity to revert to life as we all knew it pre-2020. Picture: AFP

Suddenly across the market we are seeing an unmistakeable preference building for cyclicals and cheaply priced laggards in search of the next engine for outperformance and outsized returns.

The logic behind this anticipated switch in market momentum is built on two pillars:

Pandemic winners and new era technology have become a crowded trade (everyone is in on it);

The value part of the sharemarket is too cheaply priced, in particular on a relative comparison.

So, what will shift momentum out of winners and into the laggards?

A recent market report by Macquarie emphasised that, when economies recover from the depths of an economic recession, it is always the turn for cyclicals to shine, because of their leverage to improving economic dynamics, and the return of “growth”.

The combination of extremely cheap share prices with improving prospects for growth is an enormously powerful, and attractive, proposition for investors looking over the horizon.

Most deep and gut-wrenching bear markets occur in combination with an economic recession; hence every recovery out of those bear markets has been led by banks, miners, energy companies and small caps.

Analysts at Macquarie had gone back in time and isolated four major economic recessions. And every time the pattern coming out of each of these four recessions has been similar, they emphasised — no exception. 

But still, there are doubts … why? Perhaps it is because investors have so much fallen in love with highly valued, outperforming, modern era technology companies that they simply cannot focus on anything else.

Or is it maybe because there remains a healthy dose of market scepticism about the exact shape (speed) of the economic recovery that as yet hasn’t announced itself yet, other than the initial bounce from the absolute bottom?

Shape of recovery

You would be forgiven for scepticism when strategists at Morgan Stanley — reportedly proponents of the V-shaped recovery scenario — feel the need to explain to their clientele that V-shaped recovery actually doesn’t look like a genuine V.

Morgan Stanley’s V looks a lot more like the Nike logo — the swoosh — which has a much more elongated, drawn-out right-hand part after the bounce from the bottom.

Morgan Stanley thinks the prospect of economic recovery, though not as strong as, say, post-GFC, will make investor focus switch to companies benefiting from the improvement, even if it is not as strong as recent precedents.

But the global broker also believes that, in combination with unprecedented central bank liquidity and significant government stimulus measures, the forthcoming economic recovery will create price inflation and force bond yields (long end) higher.

If correct, such a confluence of factors has the potential to create a strong self-perpetuating switch out of this year’s winners and into the laggards and the cyclicals, led by banks and energy and mining stocks.

Share rebound

In our market frothy valuations inside the technology sector have deflated somewhat, but that was always bound to happen at some stage. Banks have finally moved off their price bottoms, but Telstra hasn’t and QBE Insurance still looks “sick”; same for Nufarm, IOOF, not to mention Unibail-Rodamco-Westfield.

On the other hand, share prices for Ardent Leisure, SeaLink Travel and Event Hospitality and Entertainment have started to move strongly upwards. 

Maybe the simplest way to put a rocket under the Big Portfolio Switch in global equity markets is through the successful development of a vaccine that allows humanity to revert to life as we all knew it pre-2020. 

Sure, financial markets would soon come to realise developing a vaccine is one thing, and sharing it with billions of people worldwide is quite another, but the sheer prospect of beating the virus and being able to move on seems like a guaranteed path to keep investor hopes and anticipation elevated for a prolonged time.

Which is why the likes of Morgan Stanley have their team of healthcare specialists operating on constant alert for just about anything that can generate positive newsflow regarding COVID-19 and a potential vaccine.

According to that team’s most recent updates, the expectation remains that one of the leading contenders in this global race can start Phase III trial preparations by November and have a potential vaccine ready by late March-April next year.

This means the outcome of the US presidential election might not even be the most important news event in November. At least in the short term.

Rudi Filapek-Vandyck is the editor of stock research service www.fnarena.com

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Original URL: https://www.theaustralian.com.au/business/wealth/revenge-of-the-laggards-as-markets-finally-switch/news-story/914b76693c4d739c37414293f465654e