The recent and aggressive rotation from growth into value stocks is likely to continue over the medium term, according to Invesco Perpetual’s Nick Mustoe (pictured), who believes it is supported by strong global economic data. 
The Invesco Perpetual chief investment officer, who also runs several portfolios including the four crown-rated Invesco Perpetual Managed Income fund, says he has keenly anticipated the mass market move into cyclical sectors for some time.
He says the increased popularity of oil, commodities, financials and industrials is an important move for the firm and still has further to run.
“We’ve seen the market move very dramatically towards cyclical areas, particularly anything to do with oil and commodities but also financials and industrials, and that is a very important move for us – something we’ve been hoping for and anticipating for some time – and we think that valuation really does support this move,” Mustoe said.
“But really, we have to understand why it’s happened. It really started in the summer of last year and gathered pace and was given further impetus by the Trump victory in the election.
“I think it’s all about a change in economic policy and the fact that markets now recognise monetary policy has run its course.
“A pathway of just reducing interest rates and focusing on quantitative easing around the world, although it has saved the system from a 1930s-style depression, hasn’t engendered much growth, and the fact that growth has not been forthcoming has not helped the general electorate.
“There’s been a massive division between the high earners and asset owners, and the average population, and that really has been the background to Brexit happening and the Trump victory.”
This shift from loose monetary policy to fiscal expansion, according to Mustoe, has changed the prospects for the bond market over the medium term. This can already be seen through rising bond yields over recent months, which has sparked fears that the 35-year bond bull market could finally be over.
Performance of indices over 6months
Source: FE Analytics
Mustoe says this rise in bond yields has further to run and, as such, will continue to improve the outlook for cyclical areas of the market – particularly financials.
“We’ve seen a decent bounce in a lot of these stocks,” he pointed out.
“Some of the financials are up 40 to 50 per cent, similar moves from the oil stocks, and you have to say: well, is that enough? And we think, actually, it’s got a lot further to go if you look at valuations.”
While the rise in bond yields has slowed down over recent weeks, the chief investment officer believes this is a short-term blip in a longer term trend. He also believes energy and financial stocks have a long way to go before they approach fair value relative to history despite their stellar returns over the last few months.
Data acquired by Invesco Perpetual in the below chart shows the standard deviation in valuations across major sectors relative to their 10-year averages. This, Mustoe says, suggests that more cyclical areas are still the most attractively-valued areas of the market despite recent gains.
Standard deviation relative to 10yr average across sectors
Source: Citi
The belief that cyclicals and value stocks are attractive holdings right now isn’t shared by everyone, however. In an article published last week, FE Alpha Manager Nick Train explained he has no intention of moving into value stocks, despite being bullish on the UK.
“Sometimes other investors designate the companies we like to invest in as ‘defensive’, with the presumption that you would only invest in, for instance, Unilever or RELX because you are cautious about stock markets and feeling, therefore, ‘defensive’,” he said.
“This is absolutely not the way we look at it at all. By contrast, we are very optimistic about the outlook for the global economy and stock markets and, crucially, believe the companies we are invested in will continue to do what they have done in the past – which is to offer participation to those reasons to be fundamentally bullish.”
Fellow star manager Terry Smith agrees with the sentiment and, in a letter to investors, warned that a switch to cyclical stocks could bruise investors’ portfolios if the global economy doesn’t grow as predicted.
However, Mustoe says the macro backdrop has surprised significantly to the upside compared to this time last year, when markets were pricing in a global recession.
Performance of indices in 2016
Source: FE Analytics
“In Q1 2016, we had the big selloff of China, which started the year with markets down by 15 to 20 per cent, and that engendered a feeling of pessimism across most commentators, who downgraded their forecasts and were talking very much about the end of the cycle in the US, rather than being mid-cycle. I think that that has changed dramatically,” he said.
“You can see that these are the consensus economic numbers and, really, the whole focus on Trump’s intended policies – particularly spending on infrastructure and cutting taxes – engendering a further expansion in the economy.
“But I think, if you look in all of the regions, we’re seeing reasonable growth from subdued levels, and that does further support our view that we’re going to see a continuation of the trend of bond markets selling off gradually, and sectors that are more pro-cyclical actually doing very well.
“And I think it’s also interesting, just to look at the UK, that the consensus numbers are probably on the low side for 2017. Certainly, all of the data that we’ve seen, despite the rhetoric around Brexit, have actually been more positive than anyone would have expected, and I think that that has a good chance of continuing.”