While COVID-19 and efforts to contain it will continue to make headlines and influence the global economy, we’re all looking forward to a better 2021. With that in mind, there are hints of a “Great Rotation” in capital markets, indicating that investors are starting to envision a return to normal life in a post-COVID world. We have seen some evidence that they are beginning to favor the value and cyclical sectors that tend to prosper during economic recoveries over the growth stocks that have been leading the market.

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Hello, I’m Jim Solloway, Chief Market Strategist and Senior Portfolio Manager in SEI’s Portfolio Strategies Group. 

While COVID-19 and efforts to contain it will continue to make headlines and influence the global economy, we’re all looking forward to a better 2021. With that in mind, there are hints of a “Great Rotation” in capital markets, indicating that investors are starting to envision a return to normal life in a post-COVID world. We have seen some evidence that they are beginning to favor the value and cyclical sectors that tend to prosper during economic recoveries over the growth stocks that have been leading the market.

Although we believe it is too early to say whether this is definitely the beginning of a major secular shift in equity investment themes, the value style equity indexes have recently outpaced their growth counterparts to varying degrees across geographies and market capitalizations. This is most notable within U.S. large caps, as a look at the S&P 500® Index shows.

In relative performance terms, the S&P 500® Value Index bottomed at the beginning of September, with the S&P 500® Growth Index making a top on the same day. However, the big moves in relative performance came on November 9, the day Pfizer and BioNTech announced the surprisingly strong efficacy results of their COVID-19 vaccine.

We have observed several signs of potential normalization that seem to support a continuation of this regime change.

  • In October, U.S. Treasury yields started to tick up. However, we would be surprised if rates moved sharply higher in 2021.
  • The development of highly-effective COVID-19 vaccines has helped investors shake off worries that the pandemic would last indefinitely.
  • Regulatory developments in both the U.S. and abroad have hinted that the dominance of large technology companies may no longer be as straightforward, long-lasting or profitable as some investors have come to expect.

Casting our focus across the Atlantic, the last-minute Brexit deal at the end of 2020 provided a Christmas gift of sorts, at least in terms of removing some uncertainty.

While the so-called “skinny deal” is better than none, the U.K. has suffered from a long period of intense uncertainty. This continues to a degree, as the deal addressed the transfer of goods but not commerce in services.

Barriers to trade introduce economic inefficiencies. Post-Brexit, prices will likely end up being a bit higher, GDP a bit lower and supply chains a bit more unreliable for U.K. businesses.

Looking at the forward price-to-earnings ratio for the United Kingdom, Europe ex-U.K. and the USA stock markets, as measured by their MSCI benchmarks, we can see that the U.S. market has consistently traded at a premium valuation over the past 15 years.

That premium has widened since 2017, and expanded significantly further in 2020. The other two markets have mostly traded at similar valuations to each other over time. But a major divergence began to develop in 2019 and became more pronounced in 2020.

U.K. equity valuations, in our opinion, reflect much of the bad news. Maybe it is time for investors to think about the things that could go right.

Looking at Europe, the pandemic has actually produced one positive outcome. It finally forced Germany and other fiscal “hawks” to allow an expansion in fiscal policy. This move away from budgetary austerity should be viewed in context.

We’ve compared the increase in the primary fiscal deficit as a percentage of GDP for a handful of major developed countries. All the countries in the chart have experienced a sharp rise in red ink this year, but the biggest increases in deficit spending are outside the eurozone.

The Europeans probably can afford to run higher deficits. The memory of the European periphery debt crisis is still fresh in the minds of many policymakers; they realize that pushing for fiscal austerity measures prematurely would probably be a mistake. 

On the other hand, we think that there is greater need for other countries outside the eurozone to regain control of their finances.

If those countries fail to do so, Europe could be the beneficiary of investment flows that would further prop up the euro and equity valuations.

Globally, we expect to see signs of a recovery reveal themselves as COVID-19 abates and economic activity normalizes. In the meantime, fiscal spending and accommodative global central-bank policies should sustain GDP growth and, eventually, cause inflation to rise. As market participants price in these developments, “long-duration” assets such as bonds and stocks with very high valuations should come under pressure. Momentum investors are likely to rotate into new themes, potentially adding fuel to the value rally that has emerged.

Thank you.


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