Investment Update: Change is on the Horizon

Jeff Mortimer

The rotation under way in global equity markets has recently accelerated. Here’s a look at whether the trend will continue and what it means for investors.

We have all heard the expression, “Change is the only constant.” This is especially true in investing. Over the last few weeks we have begun to see an acceleration of the impressive rotation taking place in global equity markets. Many strategists are describing it as a switch from growth to value or large to small or domestic to international. In fact, all are right. Not only was the month of November one of the strongest on record for small capitalization stocks, but for the past three months, value stocks have solidly beaten growth stocks, and international stocks bested the S&P 500. Is this a short-term phenomenon, or perhaps the start of a long-term trend? Let’s look beneath the hood to see why this rotation transpired, if it may continue and what it may mean for your investment portfolio.

A Closer Look at the Recent Rotation

The Nasdaq 100, which is filled with stocks that have benefited from the work from home (and shop from home/medical treatment at home) theme, hit a high on September 2 and didn’t hit that point again until December 1. While it was moving sideways, other asset classes and sectors began telling a different story — one of reopening, as illustrated in Exhibit 1.

Exhibit 1: Beginning of the Market Rotation

Indeed, the month of November ushered in a series of positive developments on the COVID-19 vaccine front: On November 16, Pfizer announced over 90% efficacy; on November 23, Moderna announced over 90% efficacy; and on November 30, Moderna announced it would apply for emergency approval from the U.S. Food and Drug Administration. The news raised hopes that life could return to normal in the not-so-distant future, with the potential for a stronger economy almost in a light switch fashion. Thus, it is not surprising that the rotation from growth to value began in anticipation of the Pfizer news on November 16 and has continued nearly unabated because value stocks do better when the whole economy is doing better. Growth stocks, on the other hand, do well when growth is scarce (in the overall economy) and therefore any company exhibiting growth is sought after in times of economic softness. 

The strong market moves over the past few months appear to be linked to the common theme of reopening, which has manifested itself in a shift toward value. International stock indexes have many more value stocks (financials and industrials, for example) than their U.S. index counterparts. Small capitalization stocks have a higher concentration in financials and real estate than larger capitalization indexes.

The reopening trade has not been limited to stocks, however. Many markets around the world have been signaling the message that “better days lie ahead,” as evidenced by the price of copper, the copper/gold ratio, the tightness of credit spreads, the price of oil and long-term Treasury yields, just to name a few.

Many would say that this potential change in leadership is long overdue. Growth has dominated value for much of the past 15 years, much to the dismay of Nobel laureate Eugene Fama and researcher Kenneth French. These two showed that over long periods of time, value stocks outperformed growth stocks, and small capitalization stocks outperformed large capitalization stocks. With the last 15 years standing their research on its ear, perhaps it’s time to get back to a more “normal” environment? Only time will tell whether or not value investing will dominate growth as it has in the past, but this historical knowledge does give us greater confidence that it may. 

Looking Forward

In my opinion, this rotation has the potential to be fairly long-lasting as the global economy plays catch-up with all that has been lost in output, jobs and economic activity over the past year. As illustrated in Exhibit 2, the current equity market performance gap between growth and value and U.S. over international are both at historically wide levels. Many of these outperformance periods of one investment style over another can last for a decade or longer, with the change in leadership often taking place at the start of a “new” economic cycle. Certainly, COVID-19 has the potential — if we can end the pandemic successfully next year — to start a global economic growth cycle.

Exhibit 2: Performance Gap Historically Wide

In order to participate in this potential market rotation, we believe it is imperative to have exposure to growth and value, small capitalization and large capitalization, international equities and emerging markets. Many investors don’t like owning asset classes that have performed poorly over recent years as underperformance can sometimes last for long periods of time. However, I believe investors would be better served by embracing broad diversification across styles, capitalization and geography rather than avoiding those assets classes that may have recently lagged. 

Positioned for Change 

The Investment Strategy Committee at BNY Mellon Wealth Management, which I chair, recently took steps to implement some of the recommendations mentioned in this update. Our last asset allocation shift took some profits from U.S. large cap stocks and moved those proceeds to international developed and emerging market equities. Our view is that clients should have broad exposure to all types of markets going forward and thus, you may see us recommend similar shifts that would enable portfolios to benefit from a further reopening of the global recovery. Diversification should be your friend in the years ahead, as we believe the S&P 500 may no longer be the global leader in performance it has been for the past few years. 

“Change is the only constant” is an imperative mindset to have when investing. Anticipating that change, moving one’s portfolio to take advantage of that change and eventually reaping the benefits of proper investment decisions is our goal. We look forward to a 2021 that is very different from 2020, and believe we have recommended the proper portfolio to take advantage of this shift.

  • This material is provided for illustrative/educational purposes only. This material is not intended to constitute legal, tax, investment or financial advice. Effort has been made to ensure that the material presented herein is accurate at the time of publication. However, this material is not intended to be a full and exhaustive explanation of the law in any area or of all of the tax, investment or financial options available. The information discussed herein may not be applicable to or appropriate for every investor and should be used only after consultation with professionals who have reviewed your specific situation. The Bank of New York Mellon, Hong Kong branch is an authorized institution within the meaning of the Banking Ordinance (Cap.155 of the Laws of Hong Kong) and a registered institution (CE No. AIG365) under the Securities and Futures Ordinance (Cap.571 of the Laws of Hong Kong) carrying on Type 1 (dealing in securities), Type 4 (advising on securities) and Type 9 (asset management) regulated activities. The services and products it provides are available only to “professional investors" as defined in the Securities and Futures ordinance of Hong Kong. The Bank of New York Mellon, DIFC Branch (the “Authorised Firm") is communicating these materials on behalf of The Bank of New York Mellon. The Bank of New York Mellon is a wholly owned subsidiary of The Bank of New York Mellon Corporation. This material is intended for Professional Clients only and no other person should act upon it. The Authorised Firm is regulated by the Dubai Financial Services Authority and is located at Dubai International Financial Centre, The Exchange Building 5 North, Level 6, Room 601, P.O. Box 506723, Dubai, UAE. The Bank of New York Mellon is supervised and regulated by the New York State Department of Financial Services and the Federal Reserve and authorised by the Prudential Regulation Authority. The Bank of New York Mellon London Branch is subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from us on request. The Bank of New York Mellon is incorporated with limited liability in the State of New York, USA. Head Office: 240 Greenwich Street, New York, NY, 10286, USA. In the U.K. a number of the services associated with BNY Mellon Wealth Management's Family Office Services– International are provided through The Bank of New York Mellon, London Branch, One Canada Square, London, E14 5AL. The London Branch is registered in England and Wales with FC No. 005522 and BR000818. Investment management services are offered through BNY Mellon Investment Management EMEA Limited, BNY Mellon Centre, One Canada Square, London E1C 5AL, which is registered in England No. 1118580 and is authorised and regulated by the Financial Conduct Authority. Offshore trust and administration services are through BNY Mellon Trust Company (Cayman) Ltd. This document is issued in the U.K. by The Bank of New York Mellon. In the United States the information provided within this document is for use by professional investors. This material is a financial promotion in the UK and EMEA. This material, and the statements contained herein, are not an offer or solicitation to buy or sell any products (including financial products) or services or to participate in any particular strategy mentioned and should not be construed as such. BNY Mellon Fund Services (Ireland) Limited is regulated by the Central Bank of Ireland BNY Mellon Investment Servicing (International) Limited is regulated by the Central Bank of Ireland. BNY Mellon Wealth Management, Advisory Services, Inc. is registered as a portfolio manager and exempt market dealer in each province of Canada, and is registered as an investment fund manager in Ontario, Quebec, and New Foundland & Labrador. Its principal regulator is the Ontario Securities Commission and is subject to Canadian and provincial laws. BNY Mellon, National Association is not licensed to conduct investment business by the Bermuda Monetary Authority (the “BMA") and the BMA does not accept responsibility for the accuracy or correctness of any of the statements made or advice expressed herein. BNY Mellon is not licensed to conduct investment business by the Bermuda Monetary Authority (the “BMA") and the BMA does not accept any responsibility for the accuracy or correctness of any of the statements made or advice expressed herein. Trademarks and logos belong to their respective owners. BNY Mellon Wealth Management conducts business through various operating subsidiaries of The Bank of New York Mellon Corporation. BNY Mellon Wealth Management conducts business through various operating subsidiaries of The Bank of New York Mellon Corporation. © 2020 The Bank of New York Mellon Corporation. All rights reserved.