Here is a link to the full report. Here is a section from it:
Equity market investors seem to have figured this out too. Only 2 sectors have consistently outperformed the S&P over the last few years – Technology and Utilities. Historically, these are strange bedfellows but in a world of risk parity nirvana, they are the perfect pair – high quality growth stocks with a bond proxy. As long as rates and growth expectations continue to remain low, such a strategy seems likely to continue working in some form.
What could upset the apple cart? The risk that most people have been highlighting is when rates finally rise – e.g., 4Q2018. However, that outcome is looking more and more unlikely as long-term Treasury bonds make new all-time lows. Instead, we think it's more likely to be an excessively low level of rates that the market will no longer take as a positive for equity valuations. We think it may be more important to watch real rates in this regard. With trend in rates clear, the growth stock side of the barbell looks more vulnerable than bond proxies in the near term and on Friday.
“The Fed has got your back and they will do whatever is necessary to support asset prices” That is the mantra of stock market investors who have been following a diversified or balanced investment strategy for the last decade. In between there have been occasions when the mantra was challenged, particularly following Jay Powell’s appointment as Fed chair. However, the pivot to easier policy and the response to the repo tightness in Q3 have reasserted belief in the mantra.
Central banks are walking a high wire. If they stimulate without good reason, they will inflate a bubble of epic proportions and we have some evidence of what that will look like in Tesla and Virgin Galactic shares. On the other hand, if they wait too long and the coronavirus has a pronounced negative effect on global growth, they run the clear risk of exacerbating a recession.
European markets pulled back very sharply today on virus fears because growth is only just recovering and consumer sentiment is fragile, while the ECB is reluctant to dive back into quantitative easing, not least because of a dearth of bonds to buy. They have been admonishing governments about the lack of fiscal stimulus and this might well be the catalyst to spur change. However, a deeper reaction and at least a reversion towards the means is likely before we see clear remedial action from policy makers.
In the USA, the arithmetic is different because the coronavirus is less of a challenge for now. Additionally, the Fed is committed to avoiding a negative interest rate environment but the market is pricing in an additional suite of rate cuts as yields plunge.
The severity of the stock market slide today will certainly be a topic of conversation just about everywhere. The big decision will be on whether this is enough of a dip to buy of if a reversion back towards the mean is more likely.
The spread between bonds and equities is back at the levels posted between August and October which was a time when equity investors piled into the market. That relative value argument against a background where stimulus is almost assured is the strongest rationale for buying the dip regardless of the high valuation argument.