Submitted by Viktor Shvets, head of global equity strategy at Macquarie

Between Dante and a Hard Place

‘Abandon all hope, you who enter here’, Dante Alighieri, Divine Comedy (1308-1321)

According to Dante’s ‘Divine Comedy’, there was a mountain in the Southern Hemisphere where people needed to proceed through a purification process that removed some of their earthly sins, and according to Dante, the mountain consisted of seven terraces that encompassed seven sins (pride, envy, wrath, sloth, avarice, gluttony and lust). It was only after going through seven levels that souls finally arrived at an earthly paradise on top of the mountain.

In some ways, we feel that today’s equity investors are in a similar position. Most investors understand that buying at the top of EPS cycles and at historically high multiples, is probably a modern version of avarice (or extreme greed for wealth) and possibly gluttony, tinged with envy. The same applies to blindly following numbers while taking announcements that problems have been fixed for granted (e.g. ‘Trade war was placed on Hold’, ‘Macron Saved the World’, etc) as invitations to forget the context and get on with life, assuming that politics solve geopolitics and Central Banks fix economies (is it a sin of sloth?). Neither Dante nor the Catholic Church have ever been specific as to how long it takes to go through the circles and how many times one might need to turn back, and we believe that the same uncertainty bedevils today’s investors.

Sectoral rotations – nowhere to hide and inconsistent rotations…

Since late January 2018, equity markets have experienced regular tremors, as investors started to assess the impact of central banks’ (CBs) desire to gradually normalize their monetary policies at a time when there is growing uncertainty as to the strength and duration of a two-year old globally synchronised reflation and when co-ordination of monetary policies is becoming more difficult to enforce. Less liquidity and reflation and less co-ordination implies higher volatility rates and greater chance of policy errors causing a potentially significant erosion of asset values.

It is not even clear where should one hide, as traditionally safe places (such as consumer staples) do not seem to be able to outperform their respective indices even at times of greater stress while higher priced technology sub-sectors do not sustain the type of erosion that one would normally expect at a time of rising cost of capital. Also, value is struggling to outperform both quality and growth, particularly in global portfolios, and despite rising oil prices, investors seem to be reluctant to fully re-rate energy stocks commensurate with strength of earnings revisions.

As we have discussed in our prior reviews, there seems little value left in conventional sector rotations, based as they are on conventional business and capital market cycles that no longer exist. The combination of technological disruption and the after effects of global overfinancialization (and resultant...