It may sound a little like what you do to your car tires, but the “Great Rotation” in stocks actually tells us a lot more about what investors are thinking about markets, the economy, and more. And right now, that picture is reminding one analyst team of the period right after the surprise presidential election of 2016.
For much of this year, investors were trading as though the end of the business cycle was close at hand. Throughout this year, so-called momentum stocks were on fire. Now, investors are dumping those stocks in favor of value stocks. Ned Davis Research analysts suggest that’s due in part to markets “reflating.”
A “reflation” in markets and the economy are when inflation and interest rates pick up. The last time the term got so much press was right after the surprise presidential election of 2016. Investors believed that a Republican lock on Washington would bring about economy-boosting tax cuts, while lower tax revenues would require more government borrowing, and thus higher interest rates.
When that happened, investors sold bonds, expecting that higher interest rates would make the value of outstanding bonds, with their streams of fixed income, less valuable. The yield on the 10-year Treasury note
jumped 40 basis points over the course of one week.
Writing on Thursday, Ned Davis analysts reference “hints” of reflation in markets now, but it only takes “hints” to set off what they call a “violent reversal.” The 10-year has moved just as much over the past two weeks as it did in 2016.
Many investors are likely familiar with the “value” proposition made famous by Warren Buffet and other investors: buy low, sell high. Momentum is a little less straightforward, but a very crude shorthand might be “buy high, sell higher.”
With that in mind, the reason investors have embraced momentum this year might be: if economic growth is already at full throttle and likely to downshift from here, it’s safer to stick with the big winners. But if something – say central bank easing – buys the expansion some extra innings, there might be more value in the value trade.
As MarketWatch wrote Thursday, some of the biggest holdings in the iShares Edge MSCI Momentum Factor ETF
have outpaced the broader stock market this year. Shares of Visa Inc.
have jumped 35%, Microsoft Corp.
is up more than 35%, and Starbucks Corp. stock
is up a whopping 42%, compared to a 20% increase in the S&P 500
Meanwhile, momentum funds also tend to have a lot of defensive stocks – those that do well when the economy and bond yields turn down. If yields are reflating – turning up – that may spur selling in defensives.
There’s a similar logic behind the stocks of smaller companies compared to mid- and large-cap ones. If growth falters, companies with bigger balance sheets and more resources will weather the storm better than smaller ones, which are also often – though not always – younger.
Indeed, as the Ned Davis analysts point out, “The last time small-cap value outperformed large-cap momentum by more than 5% over two days was after the 2016 election.” The spread between two funds that track those ideas, MTUM and the iShares Russell 2000 ETF
, at the start of this week “rivals the Trump Bump,” they added.
For the week to date, MTUM is down a little more than 2%, while IWM has gained more than 5%.
Some other numbers from Ned Davis: a fund tracking gold miners
has lost 15% this week, signalling a turn away from ultra-safe assets. Another that takes a “bearish,” or negative, view on bonds
, has soared over 46%.