The US election has come and gone (almost) and markets have reacted positively to the likelihood of a Democrat President and a Republican Senate, which would be able to moderate Democrat policies such as tax increases on corporations and capital gains.
The election result, together with positive developments regarding a vaccine for Covid-19, have seen traditional value style stocks (companies deemed to be trading below their intrinsic value), including banks, rally ahead of growth stocks (companies trading at a premium for the growth they offer), such as the much-loved tech stocks, which have dominated market returns over the past decade.
It has been a long time coming, however whether the rotation into value stocks is a short-term phenomenon or a longer-term structural trend remains debatable and will be largely dependent on what bond yields and cash rates do. If bond yields and cash rates rise substantially, we may see a prolonged value rally. However, this would not be our base case as we don’t see bond yields rising materially in the short to medium term.
The rotation into value, whether a short-term phenomenon or a longer-term trend, does highlight the importance of portfolio diversification. We have observed many investors over recent years discount value style investing and traditional value stocks as a thing of the past. While it is true that there have been headwinds for this part of the market, avoiding value is, in our view, unwise as market dynamics can shift quickly, particularly in today’s environment.
Overall, we are seeing some positive signs that we believe are supportive of risk assets. Liquidity in markets remains strong, the equity premium relative to bonds still supports holding risk assets, and earnings are trending back to pre-Covid levels. Risks still remain, notably the rising numbers of Covid-19 numbers in Europe and the US, but we believe that, moving forward, selecting the right underlying investments will become as important as the asset allocation call.
