Tuesday Tidings:Playing Defense May End Up Being Very Costly

The crowding into "credible growth" stocks in a widely-fashionable mode ofinvesting has generated stretched valuations that cannot be genuinelydescribed as defensive positioning. Despite talking oneself into the notion thatbuying secular growth makes inordinate sense, given a backdrop of subpar GDPexpansion prospects, such broadly held views can be offset by the valuation atwhich such buying occurs. Indeed, privately-held “unicorns” are being written downin value even as their TAMs (total addressable markets) remain exceptionally large.

    Investors have a tendency to overpay for very visible growth and currentshort-term performance pressures may exacerbate the trend. Longer durationinvesting is out of style when asset allocators generally want consistent monthlygains with protection on the downside plus immediate liquidity, though the datasuggests that extraordinarily few managers can deliver that outcome. As a result,there has been a premium for what may be termed QAAP (quality at any price).

    Behavioral psychology has generated a flocking into quality and minimum volatilityfunds, underscoring the mindset that is considering global economic and earningsconcerns.

    Tracking fund flows can provide insight into when strategies get overboughtor oversold. One could have seen investors get too excited about Europeanequities in late 2014 and similarly in late 2015 when minimum volatility and qualitybecame the largely acclaimed trades “de jour.” When everyone plays defense, it isno longer uniquely defensive positioning and it seems like almost no one has theability to score (or outperform).

    Interest rate changes can cause a seismic shift on performance trends too. Ifone believes that the Fed will hike as the economy looks healthy enough, bondyields may be headed even higher and the value vs. growth debate takes onanother dimension. As highlighted in prior reports, different groups react fairlyconsistently over time to yield changes with more cyclical names doing better. Thecatalyst is rate changes and thus monitoring the Fed’s likely moves via respectablegrowth data (as opposed to powerfully stronger guideposts) may further the upsidein value names.

    Health Care names still look vulnerable, but the same can be said ofConsumer Staples. Valuation criteria continue to be challenging for non-cyclicalareas with the exception being biotechnology currently. Earnings revisions lookproblematic for hospitals and managed care and pricing capacity seem to beslipping for health care. Hence, buying the long-term aging demographics thememay not be that rewarding in the next year, especially given the political backdrop.