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Beware rally reversal

Cameron Micallef
— 1 minute read

The companies that offer the greatest risk for investors in 2021 are many of the same companies that have provided the greatest return to investors in 2020, an expert has warned.

According to State Street, compared with history, global equity markets are trading at expensive multiples on the back of “super accommodative” central bank policy settings and the potential for a return to normal, thanks to the vaccines.

But investors are being warned against “chasing the momentum”. 

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According to State Street Global Advisors’ head of portfolio management, Bruce Apted, while the market is expensive as a whole, some companies have been neglected despite offering compelling value.

“The (Australian) market is expensive as a whole, but some companies are extremely expensive, while others have been neglected and offer compelling value,” Mr Apted said.

“The companies that offer the greatest risk for investors in 2021 are somewhat ironically many of the same companies that have provided the greatest return to investors in 2020.

“The greatest risk is associated with those companies now priced for perfection in terms of growth, low interest rates, and a world in which investors had very few other growth investment opportunities.” 

Mr Apted also warned against the psychological pressures to join the momentum trade. 

“As prices increase, many investors will be more easily swayed by arguments for ever-increasing prices. After all, millions of people could not be wrong – could they?” Mr Apted explained. 

“Stories of your friends and colleagues retiring from their bitcoin accounts or 100 per cent returns in 2020 will entice many to jump on the trends, especially when the prices are moving exponentially. Chasing the momentum trade is especially dangerous in the later stage of the exuberance.”

Extreme valuations aren’t the only sign of exuberance 

He highlighted that while stretched valuations are a sign of increasing risks, there are also many other signs of overexuberance. 

1. Corporate behavior – Huge issuance, including IPO, SPACs, M&A and increasing corporate debt. 
2. The proportion of companies that would not be viable but for ultra-low rates and fiscal support .
3. Exponential price increases – e.g. Tesla or bitcoin.
4. Positioning – Low cash levels reflecting close to full investment.  
5. Narrow rally – A few mega capitalised stocks driving almost all the index returns.  
6. Speculation – Increase in online trading, speculation and leverage (Robinhood etc).  
7. Risky stocks are outperforming less risky stocks. 

Mr Apted told investors to stay positioned for the reversal of the risk rally, noting that “eventually the gains made by the risk trade are reversed”.

“We are currently experiencing one of these episodes, and if history is a guide, then it will likely dissipate in time,” he concluded.

 

Beware rally reversal
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