Monthly Brief May 2020 – Oversold Bounce or New Trend?
For much of the past ten weeks, the axiom that the “markets climb a wall of worry” seems to be in full force. Health and economic concerns (and now rising social tensions) continue to have broad reaching implications, yet markets appear to be increasingly focused on how, and not if, a recovery is imminent and what it might look like.
Different opinions have been promoted with “V”, “U”, “L” and “W” often used as shorthand for the shape of an economic recovery and the path that equity markets may take in response to the economic expectations. Where one stands with regards to these differing scenarios is based on how the two broadest dimensions of risk – time and certainty – are viewed.
To date, the market’s recent rebound suggests the prevailing belief is a resounding “V”. The sharp move higher since mid-March implies a strong influence by those who believe the “time” variable will prove to be a quick and smooth economic recovery as the world “reopens” (next 2-3 quarters?). And the magnitude of the rebound to-date suggests a high level of “certainty” regarding this outlook.
With equity markets continuously discounting investors’ collective view of the future, the degree to which upcoming economic and business reports either confirm or contradict the current “V” outlook will likely define where we go from here. The best-case scenario is clearly that these expectations become reality and markets can move further to levels consistent with an improving rebound in global economic conditions. But, if the conditions feeding into the “wall of worry” prove to be harder to surmount than expected, the rest of the “alphabet” may be back in play.
CHART OF INTEREST – Oversold Bounce or New Trend?
The sharp move higher in equity markets during recent weeks raises the question “When does an oversold bounce become a new trend?” Without a definitive text-book answer, investors often look to a variety of corroborating datapoints that may provide insight into the sustainability of advances in equity markets.
These moves can generally be categorized in several ways, but when markets rebound sharply from a low, the risk of reversal can be high if the initial gains are not soon supported by an improving outlook for the relevant fundamentals. Should fundamentals improve and become supportive of the markets’ initial move, a sustainable trend is more likely to continue. The stakes are high as reversals can be painful.
The current uncertainty of future economic conditions makes the contrast between growth and value stocks an insightful indicator. “Growth” stocks typically share the characteristic of the ability to grow without an economic tailwind. “Value” stocks typically need the support of healthy economic conditions as their fundamentals are often more economically sensitive. Not surprisingly, the recent market rebound in the face of high economic uncertainty has been led by a narrow group of mega-cap growth stocks. For this bounce to be better believed as a new trend, it now needs to be supported by an improving outlook for economic conditions. And this would be strongly supported by evidence of a rotation in leadership from Growth stocks to Value stocks.
This chart examines this relationship by looking at the S&P 500 Growth Index (SGX) versus the S&P 500 Value Index (SVX). The dark blue line shows the ratio of SGX to SVX. When the ratio is moving higher, growth stocks are outperforming value stocks and vice-versa and the red arrows highlight periods when value stocks have outperformed growth stocks. While value has had a few moments of leadership, year-to-date the trend still favors growth stock leadership. But, should value’s leadership become more enduring, the current market bounce may indeed prove to be a more sustainable trend.
James Ferrin, CFA
Chief Investment Officer
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