Caroline Cai from Pzena Investment Management speaks to The Inside Network’s James Dunn for our IN60 series. The Inside Adviser
The historic outperformance of big tech stocks in the US may look like a global outlier, but many developed markets (including ours) have high levels of concentration risk. That may not be the case for long, with a likely softening interest rate environment set to re-order indexes around the world.
Russell on tech stock slump
Financial advisers around the world are rightly concerned about the state of markets, with record-high prices for both equities and bonds. As previously reported, according to an Investment Trends survey of Australian investors, there has been a jump in the frequency of communications between advisers and their clients in Australia since COVID-19 hit home in March. The two-week slide in prices for tech stocks is now officially a “correction.”
While Australia does not have the same influence wielded on its market by tech stocks as in some other countries, particularly the US, there is always a knock-on effect from overseas, plus increasingly advisers are putting their clients into those offshore markets for better diversification. A research note by Russell Investments released over the weekend (September 12, Australian time) refers to the volatility as being “two-sided.”
Paul Eitelman, senior investment analyst at Russell Investments, said: “In the wake of the sharp selloff in equity markets generally on September 3, the tech sector continued to drag major indices lower for the next two weeks, to last Friday (September 11). Since the tech-fuelled selloff began, the Nasdaq Composite has dropped 10 per cent (to last Friday), meaning it’s technically in ‘correction’ territory. So, what exactly is behind the market downturn?” he asked.
“This is a bit of a strange one, as it’s hard to point to a specific event or catalyst behind the selloff. Instead, what seems to be happening is that mega-cap tech stocks are selling off simply because their valuations became a bit overextended.”
Eitelman said that at this stage, he did not believe there were any reasons to be “overly concerned” about the selloff, as many of the tech companies coming under selling pressure had experienced a meteoric rise in valuations over the last few months. However, going forward, the performance of big tech names will be an especially important watchpoint for the market, given that major US equity indices such as the S&P 500 have become highly concentrated due to the recent outperformance of the tech sector.
“At Russell Investments, broadly speaking, our equity strategies are set up to potentially benefit from a rotation from tech into the more dislocated and cheaper areas of the market, so we’ll be paying close attention,” he said. Ultimately, volatility had become more two-sided lately. He characterised this as “healthier for the market overall”. Both the Dow Jones Industrial Average and S&P 500 were up again last week, but the tech-laden Nasdaq continued lower, but at a slower pace. The broader indices would have been further ahead if their tech stocks had been excluded from the numbers.
But that doesn’t mean it’s good news, still, for broader markets. Valuations remain at historically high levels and institutional investors continue to diversify their portfolios away from listed equities, generally. Advisers should be aware that big consulting firms such as Mercer and Willis Towers Watson globally, and JANA Investment Advisers and Frontier Advisers in Australia, have been advising client funds to adopt a more defensive stance for several months – even before the pandemic struck. This could, finally, mean that out-of-favour value stocks and quality stocks could return from the wilderness if and when prices mean-revert.
The US consumer price index (CPI) rose slightly more than expected during August, climbing 0.4 per cent on a month-over-month basis, Eitelman said. While the monthly increase was the third straight for the index, which rose 0.6 per cent in both June and July, on a year-over-year basis, core prices increased by just 1.7 per cent – far below the US Federal Reserve’s (Fed’s) inflation target of 2 per cent, he said.
Inflation was likely to remain muted for a while going forward, Eitelman said, as the US continued to slowly crawl its way out of the coronavirus-induced recession. “Higher inflation typically occurs when aggregate demand is so strong that it outpaces the productive capacity of the economy to produce the in-demand goods and services,” he said. “Right now, aggregate demand is still rather weak.”
The main takeaway from all of this? The Fed would keep interest rates very low for a long time, Eitelman said, especially in light of its recently concluded policy review. “The Fed’s shift to an average inflation targeting means that it will allow inflation to overshoot its 2 per cent target for periods of time before raising rates, in order to make up for past undershoots,” he said. With this in mind, despite all the recent stimulus injected into the US economy, Eitelman believes any rate hikes are unlikely to occur until 2022 at the earliest.
