Today's focus is on style relative performance. Equity markets are underpricing the surge in Cyclicals versus Defensives earnings revisions breadth that started last year. Elevated consumer sentiment keeps us bullish on US equity markets, and China is not as worrisome as feared.In the US, value has significantly underperformed growth this year, giving up almost all of its relative outperformance that began in January 2016. We think this is a function of the weaker economic data in the US, the persistent concern about the sustainability of growth, and the willingness to pay up for secular growth and/or defensive quality – the barbell that worked so well in 2014-15 when we experienced a global recession led by the collapse in oil prices, China's "self-induced" hard landing and the exceptionally strong US dollar.
In comparison, value stocks have continued to do very well outside the US, led by Japan. This is an important contrast to 2014-15, when these regions traded more in sync with the US. This divergence supports our view that the global economy is experiencing a much more synchronous expansion that will ultimately support the US economy's acceleration that our economists expect.
This set-up suggests that traditional cyclicals and high beta stocks and sectors will have another leg of relative performance in the US. We think this favors financials, cap goods, transports, materials and even energy, which typically do well when economic growth is accelerating. We do not think this has to come at the expense of the current leaders in tech and consumer discretionary, but will more likely come at the expense of defensive and quality sectors and factors.
Consumer sentiment and other confidence surveys have remained persistently elevated in the US. Our analysis of such measures suggests this is a rare phenomenon and supports our more bullish than consensus view for US equity prices over the next year. The contrast between economic and investor confidence is striking and reflective of the scar tissue that remains from the financial crisis of 2008-09.
In our meetings with both institutional and retail clients, we find their concerns to be generally vague and centered around valuation and the length and magnitude of the rally. When pushed, investor concern almost by default comes back to China's slowing this year and the potential for another repeat of 2014-15. We think such an outcome is unlikely, so a reversal of economic news flow from China could also serve as an important catalyst for the next leg higher in US equities, led by value/cyclicals.