Based on all of the factors, our Q3 outlook remains bullish on value and cyclically oriented stocks, adding to growth stocks as a hedge. We also see relative opportunity in Developed Market equities. We outline our key takeaways and trade details below in more detail.
If you’ve been following the industry, some are suggesting that a “market shakeup” has occurred. They point to a reversal in rate and inflation expectations, a rally in tech, and sell-offs across cyclicals (short-term or seasonal stocks) as indicators.
This notion of a ‘market shakeup’ is simply not consistent with several consecutive quarters of positive earnings surprises and persistently strong economic data. It appears overdone and does not justify such a dramatic repricing of lower growth and inflation expectations.
We stay convicted that the market rebound continues, with cyclicals (short-term or seasonal stocks) leading the way. Added hedges will help mitigate any potential vulnerabilities in this approach.
Three narratives have emerged, predicting a “sustained trend reversal,” or a sustained downward slide of price trends (reversal of current direction).
We find these narratives less than convincing and do not reflect our outlook moving forward.
The first narrative claims that the Fed will move to slow down asset purchases and raise interest rates sooner and more aggressively. We believe the Fed will remain patient.
The second narrative recognizes the emergence of the new Delta COVID-19 variant and worries that it will disrupt the economic restart. As stated above, we believe the successful vaccination programs across Developed Market economics (and some Emerging Market economics) will allow continued economic growth and prevent the ‘shutdown’ measures seen during the heart of the pandemic.
The last narrative says that either the current elevated inflation is ‘transitory’ or that the pre-COVID trend of disinflation and anemic growth will reappear.
While we aren’t so sure about the current elevated inflation being ‘transitory,” we disagree with the suggestion that pre-COVID trends will re-appear. We see housing and rent inflation, wage growth, a booming demand for energy, and corporations emboldened with pricing power as potentially durable drivers of inflation.
The U.S. economic expansion continues to be driven by record amounts of consumer savings, wealth creation, and pent-up demand.
European and other international Developed Market economies have lagged in recovery due to delayed vaccine rollouts.
As the economic restart moves beyond the U.S. to these economies, following a similar trend to the U.S., we see potential opportunities in Developed Market equity investments.
Our overall approach is to position ourselves for rising rates and inflation expectations.
That being said, we believe it will be best to diversify with strategic allocations towards both cyclical and secular growth - both short term stocks and stocks that remain consistent over time.
A diversified approach will help protect the portfolio against the effects of a flattening yield curve - if market sentiments remain negative.