Volatility Equities Blog

Global Equities

Keeping Balance in a Wobbly World

07 October 2019

4 min read

Chris Hogbin| Global Head—Investments

Global stocks advanced in the third quarter, but investor sentiment wobbled amid puzzling signals on macroeconomic growth and monetary policy. Political uncertainty and a cloudier outlook point to more volatility, which should compel investors to intensify their focus on stock fundamentals.

Developed market stocks were led by Japan, while Chinese stocks advanced despite the weaker trend in emerging markets. The MSCI World Index increased by 1.5% in the quarter and was up 18.5% for the first nine months of the year, in local currency terms. But the real drama unfolded beneath the headline numbers. In September, style return patterns took an abrupt turn, with value stocks outperforming growth in a rising market for the first time since late 2016, particularly in US and European large-caps. While growth stocks still slightly outperformed value stocks over the entire quarter, the move showed just how sharply sentiment can shift, and why style diversification is important.

3Q Return Patterns: Most Markets Advanced, Style Returns Shifted

As of September 30, 2019
Past performance and current analysis do not guarantee future results.
*Japan represented by TOPIX, Australia by S&P/ASX 300, Europe ex UK by MSCI Europe ex UK, US large-caps by S&P 500, UK by FTSE All-Share, China by MSCI China A, emerging markets by MSCI Emerging Markets and US small-caps by Russell 2000
†Based on MSCI World Growth and MSCI World Value indices, in local currencies
Source: FactSet, FTSE, MSCI, Russell Investments, S&P, Tokyo Stock Exchange and AllianceBernstein (AB)

Style Shift: Short-Term or Sustainable?

What can explain the sudden appeal of value in September? The rotation could have been triggered by many things, including relative valuations and technical factors. But macroeconomic expectations certainly played a big part, in our view. Bearish sentiment appeared to peak in August and gave way to small doses of good economic news. Global manufacturing showed signs of life, as the PMI for August increased after 15 straight months of decline.

Bond yields reflected some of this optimism. The 10-year US Treasury yield bottomed out at 1.43% in early September, then clawed its way back to 1.90% by mid-month, before falling back to 1.68% at quarter-end. US and global economic surprise indicators improved. The possibility that growth expectations may have become too pessimistic helped fuel returns for stocks that are more sensitive to the economic cycle, which are typically among the most attractively valued cohort in the market.

Economic Outlook: Which Way Is Up?

Still, it’s tough to draw a conclusion from such a short-term move, and the global economic outlook faces many challenges. Uncertainty driven by the US-China trade war remains a big obstacle to sustainable growth, especially in regions that are driven by manufacturing, such as Europe and Japan. Consumer and capital spending have held up so far, but could be vulnerable if manufacturing weakness persists. Volatile oil prices and Brexit disarray add more confusion to the outlook.

This tug-of-war for investor sentiment will probably continue, in our view. Since expectations for the global economy are so low, any nugget of good economic news could spark a risk rally. Major central banks are widely expected to keep monetary policy loose for the near future. At the same time, since multiple geopolitical and macroeconomic risks remain unresolved, investors are quickly spooked and easily revert to defensive postures.

Equity Valuations Look More Reasonable

Where does this complicated situation leave equity markets? After all the ups and downs, global stocks haven’t really budged much over the last year. At the same time, earnings have risen by more than 4%. As a result, price/earnings ratios for global stocks have slipped by about 4% over the last 12 months, making them more reasonably priced than a year earlier (Display, left).

Meanwhile, the 10-year US Treasury rate fell by about 140 basis points over the same period. As a result, the equity risk premium—or the excess return investors can expect from investing in stocks over the risk-free rate of government bonds—increased to its highest level in three years (Display, right). If interest rates rise substantially over a sustained period, this premium would be threatened. But in current conditions, we believe that the potential reward for owning equities is attractive.

Equity Valuations Have Moderated, Risk Premium Looks Attractive

As of September 30, 2019
Past performance and current analysis do not guarantee future results.
*The equity risk premium is the spread between the 12-month forward earnings yield of the MSCI World and the 10-year US Treasury.
Source: FactSet, MSCI and AllianceBernstein (AB)

Volatility Will Be a Menace

For many investors, the attractiveness of equities is offset by concerns about volatility. In today’s environment, these fears are understandable—and volatility is unavoidable. Yet while it’s impossible to forecast short-term fluctuations in outlook and sentiment, it doesn’t mean that there is nothing you can do about it.

In particular, investors should make sure that their allocation is properly matched to risk tolerance. In many cases, that means making sure that an investor can withstand the type of swings we have experienced over the past year or so, which are likely to continue.

It’s especially important to avoid overreacting to seemingly daily shifts in market leadership. Often, this type of tactical reaction can be a recipe for disaster and may undermine long-term investing objectives.

Strategic Diversification Is Essential

Instead, it’s important to ensure that effective, strategic diversification is in place—not just in individual portfolios, but across your asset allocation. Different styles or factor exposures are primed to succeed in different environments. With proper diversification, an investor is likely to benefit from some winners even if other parts of a portfolio are more challenged. It’s impractical to shift too much of an allocation during episodic style shifts. However, the recent quarter illustrated why it’s important to have exposure to multiple styles that are likely to generate long-term outperformance, albeit at different times.

Active managers can take advantage of today’s volatility by building positions in stocks or sectors that may be temporarily mispriced when emotions overwhelm fundamentals. Given all the short-term noise, we believe that long-term investors have an opportunity to see through the uncertainty by focusing on company business models and fundamentals.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

About the Author

Chris Hogbin

Chris Hogbin is the Global Head of Investments for AB. In this broad leadership role, he oversees all the firm’s investment activities. Hogbin is responsible for driving investment success across asset classes, fostering collaboration and sharing best practices across investment teams, as well as leveraging a common infrastructure and evaluating opportunities to invest in capabilities that deliver better outcomes for clients. He is also a member of the firm’s Leadership team and Operating Committee. Hogbin joined AB’s institutional research business in 2005 as a senior analyst covering the European food retail sector. In 2010, he was named to Institutional Investor’s All-Europe Research Team and was ranked as the #1 analyst in his sector in both 2011 and 2012. Hogbin became European director of research for the Sell Side in 2012 and was given additional responsibility for Asian research in 2016. In 2018, he was appointed COO of Equities for AB. In 2019 Hogbin was promoted to co-head of Equities, becoming head of Equities in 2020. Prior to joining the firm, he worked as a strategy consultant for the Boston Consulting Group in London, San Francisco and Shanghai, where he was responsible for the execution of critical business-improvement initiatives for clients in the financial-services and consumer sectors. He holds an MA in economics from the University of Cambridge and an MBA with distinction from Harvard Business School. He is a trustee of the Public Theater in New York.

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