The danger of “extremes” is around the corner
Caution is needed in the face of the market’s above-consensus outlook. It is fine to play the “reflation trade” card, but not at the risk of overexposure. Better to focus on the sectors that have been forgotten
The markets are optimistic, maybe too optimistic, so much so that there are signs of an above-consensus scenario in which investors are at risk of getting their fingers burnt. Alarm bells are ringing in many quarters, or rather it is the almost stellar performances recorded by some sectors riding the “reflation trade” wave that are cause for concern, for example the more cyclical sectors such as energy and finance, which in the last four months have recorded increases of 68.74% and 30.10% respectively. Against the background of such excesses, would it not be better to turn our attention to other sectors, currently forgotten by the market?
In fact a situation is being created that is diametrically opposed to 2020, when in the teeth of the pandemic everyone feared the worst and flooded the market with sales, causing prices to literally collapse. But it was not the end of the world. Indeed, within a month the Stock Exchanges had reacted, quickly fighting back and in some cases, as in the United States, even reaching pre-COVID levels.
This year, however, we are moving towards the other extreme. The economy is on the road to recovery and everyone is positioning for this “reflation trade” view. On the markets they talk of nothing but out-of-control rates and inflationary risk, but extreme and excessively consensual views have never proved to be the wisest options, as shown by very recent history (the crisis of 2020, not to put too fine a point on it).
This does not mean to say that the “reflation trade” card should not be played, but it is necessary to move with caution and, in this above-consensus situation, maybe even start to take profit from stocks that have taken great advantage of sector rotation, starting with energy and finance.
Even the world of technology and long duration equity, with expectations of rate rises, have begun to waver, with the Nasdaq falling by around 5 per cent after peaking at 14,095 points on 12 February. But even in this case we cannot generalise as not all of the world’s tech and digital companies present the same characteristics. Against stocks whose valuations are objectively difficult to justify, even discounting best-case scenarios, there are many others that are very reliable, with brilliant prospects and valuations at attractive levels.
So it is better to lighten the load on stocks that are not sustainable in the long term and switch focus to sectors that have been neglected by the market. Prime candidates are staples, utilities and pharmaceuticals, which over a rolling 12-month period have far underperformed the S&P 500 index.
From the perspective of good, sound asset allocation, overexposure on individual stocks has always been risky. So even if on the one hand we say yes to “reflation trade”, on the other hand we urge caution and should avoid concentrating too much on a small number of sectors.
In 2020, when everything was collapsing, we foresaw a historically rare window of opportunity for the markets, especially for those for whom the time was right.
Now we find ourselves at the opposite extreme and the same alarm bells are ringing about the danger of an above-consensus outlook. What should we do? Avoid following the masses and look for hidden value.
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