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Key take-aways

  • Despite our preference for defensive growth stocks, we recommend adding financials as an inexpensive hedge against higher yields and inflation.
  • Within global financials, we advise a focus on high-quality companies with first-class balance sheets and strong profitability.

Valuations are for the patient. When investing, the immediate driver of performance is rather what everybody else thinks about equity markets. Investor positioning defines 3–6 months of the price action, then the monetary regime takes over as the main driver for the returns of risk assets – for up to two years. Only then does valuation emerge as the main driver on stock markets. Yet from the investors I have met, hardly anyone has the patience (or can afford) to wait 3–5 years for an investment to pan out. First of all, the professional crowd would be out of a job before reaping the benefits of such a long-lasting call. Meanwhile, private investors get itchy if they hear others bragging about their glamour stocks at parties and usually flock out of their value investments to join the momentum party before value pays off.

This is particularly interesting in a time when the common narrative is about ‘the bubble of everything’ a.k.a. ‘everything is expensive’. Well is it?

Recommendations for investors
With the mid-cycle market transition in full swing, we continue to recommend switching into defensive growth stocks, especially in the information technology (IT) and healthcare sectors, which should continue to do well at this point of the cycle. That said, visibility around the inflation outlook continues to remain low. As such, we continue to recommend adding inexpensive hedges against higher yields and inflation, such as financials. Across the global sector universe, financials remain the most positively correlated to inflation expectations and interest rate levels. Historically, financials have strongly outperformed in an environment of rising yields and a steepening of the yield curve. Our year-end forecast of 1.95% for the US 10-year Treasury yield implies an outperformance of 12% for financials versus the broad market.

Moreover, relative valuations remain highly attractive. Based on the relative 12-month forward P/E, financials are trading at a 25% discount to the long-term historical average. In the case of a regime change towards higher inflation and rates, the sector offers a very attractive upside. Lastly, before the coronavirus outbreak hit the global economy, financials had turned into a shareholder return story. After a temporary halt due to the pandemic, banks have now resumed their share buy-backs and dividend payments. The market-leading shareholder cash returns (as high as 6.2% for EU banks, see Number Of The Week), should support share prices in a negative real-yield environment. Against this backdrop, we recommend to Overweight financials alongside IT and healthcare stocks in a global equities portfolio.

Number Of The Week

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