Macro factors may not have much to do with stock markets
It’s counterintuitive to think that as global growth prospects look better and better, value shares have benefited more than growth stocks. So much so that they have gained sufficient impetus to pull ahead of a universe that has been dominated by sharp rallies in Big 5 tech stocks during the pandemic.
During May, the MSCI Growth Index slipped 0.13%, but the MSCI Value Index gained 3%. In the year to date, the outperformance is even more pronounced, with growth shares (up 6.5%) delivering less than half the performance of their value counterparts (16.7%).
These performance differentials back up investment views of earlier this year that value would likely overtake growth after years of underperformance. At the heart of the shift in relative performance are the upbeat global growth prospects and the associated rise in inflation expectations.
There is some debate about how much macro factors contribute to the performance of stock markets. Recent research conducted by Goldman Sachs Asset Management found that, although economic growth may influence equity performance, micro matters more, with most performance coming from stocks and not countries.
Theory
Goldman Sachs says that, according to economic theory, “growth influences equity markets in stages: 1) higher corporate profit growth, which leads to 2) higher EPS [earnings per share] growth, which finally translates into 3) an increase in stock prices. While such a progression makes intuitive sense, in practice, we do not see a particularly strong statistical relationship.”
Historical data indicates some positive influence on equity market performance – but not to a material extent. The strength of the relationship is 0.3, versus a perfect correlation of 1.
When it comes to stock selection, Goldman Sachs points out that data since 2010 shows “a significant proportion” of international fund managers have delivered returns in excess of their passive counterparts through their active stock selection. Its analysis puts the outperformance of emerging market and foreign large-cap managers versus the median passive fund at 3.8 percentage points and 2.3 percentage points, respectively.
From a macro perspective, it would be difficult to attribute the outperformance of emerging-market stock markets of late to their economic growth prospects because they lag advanced economies in an increasingly bifurcated global economic recovery.
Nevertheless, the MSCI Emerging Market Index delivered 2.3% in May versus the MSCI World’s 1.2%. An increasing number of fund managers have expressed a preference for carefully selected emerging markets rather than the shares listed in advanced economies and trading at much higher valuations.
Still, there seems little sign of a turnaround in the rise in developed stock markets. Last week global equities reached a new high, and the S&P500 remains within easy sight of its all-time high. US stock markets have come slightly off the boil in May and early June, with the S&P500 0.5% ahead after the first week and the Nasdaq 1% after declining 1.2% in May.
Volatility
Equity market volatility, as measured by the CBOE VIX, the so-called global fear index, has also subsided to around 16 compared with the 37-plus high reached in late January this year. According to Bloomberg, volatilities across other assets, including corporate bonds, government bonds and foreign exchange, have been declining too.
But before you get lulled into a false sense of complacency, remember that the inflation debate is nowhere near ending and, with Eurozone inflation coming in at 2% this week and the US consumer price index set to be released within the next week, it may be the calm before the storm.
Yet UBS global chief investment officer Mark Haefele is confident that the stocks prospect is positive, justified by the positive economic backdrop, a strong earnings outlook, and continued policy support. “With growth accelerating, we think the economic outlook is benign for stocks and expect cyclical parts of the market to outperform.”
It’s hard to bank on any definitive views on where the economy or financial markets are going when many unknowns lie ahead. Although arguments in favour of equities can be convincing, when volatility re-emerges, as it will, it will probably prove much wiser to be invested in a diversified portfolio across asset classes and regions.
Sharon Wood is a freelance communicator.