Equities: too far, too fast?

31 January 2020

4 minute read

By Julien Lafargue, London UK, Head of Equity Strategy

Equities have started the year with a bang, with some markets setting fresh highs. With valuations stretched and another rollercoaster year on the cards for investors, we believe staying disciplined through it all is appropriate.

Equity markets continued their relentless march higher thanks to unabated multiple expansion in January. The market seems to have run ahead of itself, though. While there is a risk of further overshoot driven by acronyms such as a FOMO (Fear Of Missing Out) or TINA (There Is No Alternative), we question how long such enthusiasm for equities can last.

Reasons to stay optimistic

The bull argument is simple: the world will remain awash with liquidity while the economic backdrop is improving. Indeed, the bar for central banks changing course and tightening monetary policy still appears elevated given subdued inflationary pressures. In addition, although uninspiring, earnings growth is set to resume in 2020. And finally, the main uncertainty that has affected markets over the past year or so, namely the trade tensions between the US and China, has been reduced.

This goldilocks scenario is further supported by expectations that the US president will do everything he can to boost equity markets ahead of the November election.

Is 20 the new norm?

Although fundamentals have yet to show signs of improvement, the above arguments were sufficient to propel stock markets to decade-old record highs. Investors now appear convinced that paying 19 times forward earnings in the US, something not seen outside the early 2000s dot-com bubble, is justified.

Furthermore, given the low interest rate environment, a valuation multiple of 20 is not out of reach according to some, at least until the recent developments related to the coronavirus. We remain sceptical of this, although our bull case (multiples to expand by another 1.5 points vs. the end of the third-quarter 2019) may be more likely to materialise.

Beware of euphoria

While accommodative monetary policy certainly provides strong support to risk assets, valuations can’t ignore the reality of the economic cycle forever. While the risk of recession, or at least significant slowdown, seems to have receded, we continue to believe that growth is unlikely to re-accelerate meaningfully. The recent outbreak of coronavirus in China certainly clouds the short-term outlook.

Valuations can’t ignore the reality of the economic cycle forever

We also struggle to reconcile the market’s current narrative that a rebound in growth will be accompanied by further easing from central banks. Surely, if activity stabilises, the incentives for hiking interest rates will be higher.

Staying disciplined

In this tug of war between bulls and bears, we believe that the most appropriate strategy is to remain disciplined. Chasing cyclicality and beta may sound appealing in a melt-up scenario but the prevalent optimism would leave us exposed to any negative surprises – and there will be some along the way. Similarly, taking profits and “waiting for a pullback” remains a loss-making proposition over the medium term. Instead, we see merits in staying invested while adjusting the risk/reward of portfolios.

Diversification, diversification, diversification

We want to maintain a healthy balance between defensives (such as healthcare) and cyclicals (consumer discretionary and some industrials) but with a clear focus on “quality”. Although this strategy may lag in a strong bull market, it should still provide attractive returns over time.

In addition, we believe that tactical hedging makes sense when appropriate and cheap enough. Finally, we see benefits in favouring active versus passive management given the dangers of chasing “beta” in the current environment.


Market Perspectives February 2020

Barclays Private Bank investment experts highlight our key investment themes. Despite a strong start to 2020 by financial markets, trade tensions and rising geopolitical risks feed into a general feeling of apprehensiveness.


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