Independent Pilots Financial Services is part of the Benchmark Capital Group, backed by FTSE 100 company Schroders. Our investment committee often draws upon Schroders vast resources. This piece is written by one of their investment writers.
The extraordinary market moves in the first half of 2020 disrupted some of its most persistent trends, but Robert Donald and Ashley Lester explain why they won’t disappear so easily.
During the pandemic we have seen some extreme swings in stock markets.
The longest bull-run in history, which started in March 2009, came to an abrupt end in early February when markets crashed in equally record-breaking fashion.
The Dow Jones Industrial Average index of US stocks (‘the Dow’) fell by over 30% in only 25 trading days from 6 February. The shortest, sharpest correction in history. Even quicker than the crash in 1929, which preceeded the Great Depression.
As central banks and governments announced ever more extraordinary measures to protect jobs and the economy, stocks rebounded. By early June, US stocks had erased all their Covid-19 losses.
Along the way some well-worn market trends also seemed to be reversing.
For instance, European stocks outperformed US stocks in mid-March. US small companies outperformed large ones in mid-April. And value outperformed growth in mid-May in the US.
However, these reversal of trends were brief in their duration. We spoke to Ashley Lester, Head of Systematic Trading, and Robert Donald, Chief Investment officer at Helix, to find out which trends might be here to stay.
What has been going on in markets?
Ashley Lester: “Until recently, the big picture trends in terms of which stocks have done well and which stocks have done poorly remained in place.
“The most profitable stocks – growth stocks – did great, comparatively. The cheaper value stocks and the smaller stocks got absolutely smashed.
“In fact, the degree of their underperformance has been really quite historic over the last year and a half.
“You can measure how unusual the performance is by looking at standard deviations (SD). That is, how much returns deviate from the average “normal” return, or the mean.
“A move of 1 SD is the sort of thing that you should expect to see happen all the time. A 2 SD move is something that you should expect to see once every five or ten years.
“You should never in your career see a 3 SD move. By the time you get to 4 or 5 SDs, arguably, you should never see that in the whole history of the universe.
“Well, in US stock markets during March, cheap stocks underperformed by about 4.5 SDs and small stocks underperformed by about 6.5 SDs.
“What that is telling you is that the size of moves in March were just truly earth-shatteringly enormous in terms of the relative valuation of these two types of stocks.
“What we have seen since is maybe a bit of a comeback of cheaper stocks relative to more profitable stocks. But, I would not want to get too excited about it because they have got an awfully long way to go.”
Why has growth outperformed value for so long?
Robert Donald: “The snap-back in economic growth since the global financial crisis 10 years ago has been, relative to other recovery periods, more muted.
“In a muted world, growth becomes a scarcity. So, the market will pay a premium for quality, for cash conversion (turning profits into cash), and for growth. That is exactly what has happened.
“A very narrow subsector of the market, the likes of the tech giants, has been doing well – basically over-earning and taking the dollars from a limited pot of cash.
“More traditional companies, whether they be in the banking sector or in the resources sector, have been struggling.
“Then, when Covid-19 came along, all sources of growth and demand were put on ice.
“The few industries which were still functioning in a stay at home environment such as the tech giants – which happened to be the same leaders that we had seen do disproportionately well – got rewarded.”
What might the trend be going forward?
Robert Donald: “Over the next two to five years those companies which exhibit that growth profile, will continue to do well because growth is going to be a scarce feature.
“Corporates are highly indebted, they don’t have the confidence to reinvest in capital equipment.
Consumers are wary of their job security and therefore will hold back and keep an element of their income as savings. Governments themselves are going to be very heavily indebted.
“I think that these things will conspire to undermine growth and this narrow market leadership will probably persist.
“I have some sympathy with the view that, in a V-shaped recovery, there could be a pocket of activity which will favour some of the more traditional industries. Because the aggressive monetary and fiscal policies will lift those businesses for a moment in time.
“However, once we get through that sugar rush and then look on the other side of the hill, there will be a realisation that there will be a lack of growth.”