NEW YORK: Sometimes, when volatility jolts financial markets, the safest trades can quickly morph into dangerous bets.
That is what’s happening now in some corners, as investors spooked by the bank crisis and central bank uncertainty crowd into big-tech stocks and highly rated corporate bonds.
The rush for defensive assets has made both so expensive relative to history that they could be prone to painful reversals.
Legal and General Investment Management and RBC Wealth Management are among the funds retreating from a blistering rally in tech stocks.
Goldman Sachs Group Inc, meanwhile, has identified a cheaper and safer strategy in low-volatility stocks.
“That is the danger now: to get fully defensive and buy overpriced assets,” Frederique Carrier, head of investment strategy at RBC Wealth Management, said in an interview. “Defensive sectors have become somewhat pricey, and that is why we are not 100% up in quality.”
Across the spectrum of recessionary outlooks, from those who expect a soft landing to those bracing for a hard one, money managers have been gravitating to quality to shelter from the economic fallout of the collapse of three US banks and the government-sponsored bailout of a fourth in Europe.
The quality-heavy top 20 largest stocks in the S&P 500 have driven the stocks rally since the beginning of the year, with the index currently trading at a price-to-sales ratio above the dot-com bubble’s peak.
Similarly, in Europe, quality defensives are trading at around a 60% premium to the Stoxx Europe 600.
Patrick Armstrong, chief investment officer at Plurimi Wealth, just sold out of his position at the luxury giant, LVMH, as he sees too much safety premium being priced into certain quality names.
He continues to hold Apple Inc and Alphabet Inc but sees the risk of a period of “dead money”, where it takes a long time for performance to catch up with trading multiples.
“If you feel safe owning it, it’s probably too expensive,” said Armstrong on Bloomberg TV. “A mean reversion trade is very likely.”
Long big tech stocks are currently the most crowded trade, and investors are holding the most bullish positioning in investment-grade credit versus high-yield on record, according to Bank of America Corp’s latest fund manager survey.
This reflects investor confidence that big tech companies with rock-solid balance sheets and high free cash flow will weather a recession better than many companies saddled with heavy debt loads.
Minutes of the US Federal Reserve’s last meeting showed policymakers scaled back expectations for rate hikes after a series of bank collapses roiled markets and bolstered forecasts of a “mild recession” starting later this year.
At the same time, the potential that central banks will temper aggressive rate hikes and eventually pivot to an easier policy may drive further gains.
The link between the tech-heavy Nasdaq 100 index and duration, a measure of rate sensitivity, could spell double-digit gains with every rate cut.
“It’s not necessarily expensive for the late cycle position we are in,” said Christian Mueller-Glissmann the head of asset allocation for portfolio strategy at Goldman Sachs Group Inc, confident that although pricier, quality trades will outperform in a decelerating growth environment.
Still, he’s recommending investors add exposure to low-volatility stocks, which are expected to remain stable in churning markets while sharing characteristics like strong balance sheets and profitability with more expensive, quality peers. — Bloomberg
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