July 17, 2020
Value: The outperformance from value sectors (Financials, Materials and Energy) this week looks more like portfolio rebalancing than a large scale commitment to the group. Portfolio Managers were underweight Financials coming into Q2 earnings based on concerns over massive reserve builds and reserve guidance. They got the massive builds and enough cautious optimism in guidance to take weightings back toward average. A more pronounced near-term commitment to value sectors is not out of the question if COVID-19 metrics in current hotspots continues to follow the model. Coronavirus related hospitalization trends in AZ and TX are showing early signs of deceleration with CA looking about a week behind. We see no reason why the reaction from markets would be different than it was when case growth peaked in the first two waves in the Northeast and Midwest/Mid-Atlantic regions.
Contrarian: Bearish equity sentiment remains too elevated and equity positioning indicators too light for the SPX to experience a near-term correction. Equity fund outflows during the week ending July 15 totaled another $8.9B vs outflows of $1.5B in week ending July 8. Meanwhile, taxable bond funds last week saw inflows of $5.3B.
Equity risk premium: Using a two-stage DDM and a gratuitous risk free rate assumption of ~0.70% gets you a higher than normal equity risk premium. The equity risk premium is the return above the risk free rate that investors should expect from equities. Even using the most conservative inputs, it’s difficult to get a number under ~9%.