Dare face the consequences of the year-end rally

Dare face the consequences of the year-end rally

12 November 2019 from Mikael Syding

Dare face the consequences of the year-end rally

All major stock markets have risen sharply this fall, contrary to what many feared. Does that
mean we simply got the Christmas presents extra early, or is there more on the upside? Is the
year-end rally perhaps already over? Should you be contrarian or follow the trend for a while?
And which sectors are the best way to take a position for the rest of the year?

To begin with, we can conclude that it is not growth and profit prospects that have driven the
upturn. On the contrary, the gap between the multiple expansion and the forecast reductions is
extremely large. For example, the Price to Earnings ratio for the Russell 2000 index of small companies (the twothousand companies with the lowest market value in the Russell 3000 index) has increased by 45%, while profit estimates have fallen by 22%. It doesn't look quite as bad for the S&P 500, but the big companies usually lag behind, and have access to more "creative" accounting experts. Nevertheless, EPS forecasts have fallen by 4% and the Price to Earnings multiple has risen by 24% this year.

The trend is often one's best friend in the stock market, but this trend is hardly sustainable.
Either the forecasts must soon be adjusted upwards, or the reality will catch up in the form of
falling multiples. Or does it really have to? When things have already gone this far, why
shouldn't continued liquidity flows be able to drive stock prices even higher? The US central
bank has just begun an interest rate reduction cycle and also started with Quantitative Easing (QE) on a large scale (Powell firmly argues that it is not QE only emphasizes that it is just what it is). Perhaps it could also cause the dollar to be a little less strong, which would stimulate the US economy and reduce the stress in both the euro-dollar system and emerging markets that are currently suffering from dollar shortages.

The constant hope for a solution to the US-China trade war, as well as increased monetary
stimulus, are behind the stock market surge this year. The focus has also been on the
technology sectors software and IT services, while energy, for example, has lost ground. In a
presentation this week, Hedgeye showed how in the last ten years the energy sector has
reduced its weight in the S&P 500 from 13% to just over 4%, while IT has increased from just
under 7% to 12%. It may simply be time to dare to step off the train for IT as a way to reduce its
equity risk.

At this time of year, the recommendation is usually to ride the Santa rally by buying more of the
winners and selling the losers (because that's what the pros do to window dress portfolios with
this year's "best" stocks). However, this year is far from normal, exemplified by surge of +20% at
the same time as declining growth and declining profit forecasts. The Purchasing Manager
Index and capital goods orders data look like the companies already know that the recession is
imminent, an impression that is only reinforced by a dovish Fed. Also, keep in mind that the Fed
lowered interest rates quickly throughout the stock market collapse 2001-2002 and 2008, so the
last three cuts are not positive signals.

I'm not saying it's different this time. On the contrary. The last five years have been
characterized by short and fast stock cycles in a relatively stagnant economy. This is especially
true in Europe, while the United States has subtracted mainly from highly valued technology
stocks. I think it will continue to look the same way, as long as profits do not take off and it is
difficult to achieve with record debt in all sectors of society.

So, do not stare blindly at the season and hope that Santa is on the way. Instead, expect
continued sideways volatile market, and dare to be contrarian when the stock market has
unjustifiably risen or fallen by about 20%. Last year, for example, the prospects look extremely
bleak during the second half of the year, but the turn since then has been as unexpected as
spectacular. There are many good reasons to expect a full turnaround now, just as most are
hoping for a new secular market and chasing winners.

Dare to believe that nothing has changed and think about switching from the winners to the losers before everyone else does. If you are really brave, you get off the stock train altogether and look at US government securities, gold or soft commodities, but otherwise it may suffice with a smart sectoral rebalancing.

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This information is in the sole responsibility of the guest author and does not necessarily represent the opinion of Bank Vontobel Europe AG or any other company of the Vontobel Group. The further development of the index or a company as well as its share price depends on a large number of company-, group- and sector-specific as well as economic factors. When forming his investment decision, each investor must take into account the risk of price losses. Please note that investing in these products will not generate ongoing income.

The products are not capitalprotected, in the worst case a total loss of the invested capital is possible. In the event of insolvency of the issuer and the guarantor, the investor bears the risk of a total loss of his investment. In any case, investors should note that past performance and / or analysts' opinions are no adequate indicator of future performance. The performance of the underlyings depends on a variety of economic, entrepreneurial and political factors that should be taken into account in the formation of a market expectation.

27/01/2021 04:17:38


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