Strategy Report: Tactical sector rotation to cyclicals

There are signs of value stocks starting to outperform growth stocks over the past two weeks. We see supporting fundamental factors behind this sector rotation, as well as short-term confirmation signals from relative momentum. We suggest tactically shifting to cyclical sectors including financials, property and machinery.

 

  • Rotation from growth to value underway. Since the outbreak of COVID-19 in Q1, growth stocks led by tech have been outperforming value stocks significantly. Over the past two weeks, however, the tide is turning in both U.S. and HK markets. With the premium of U.S. growth stocks over value stocks at its highest in at least two decades, and U.S. tech stocks being the “most crowded” trade, there could easily be profit taking in growth stocks and at the same time catching up in value stocks given the right catalysts.

 

  • Fundamental catalysts for the rotation. We see several catalysts supporting the rotation into value stocks: 1) upbeat economic data; 2) rising inflation expectations and bond yields bode well for financials; 3) positive news on COVID-19 and vaccines; 4) U.S.-China tension weighing on tech sector.

 

  • Momentum of sector rotation confirmed in the short term. Relative Rotation Graph (RRG), a tool to gauge and forecast sectors' relative performance, confirms short-term rotation from tech to cyclicals in HK market. Compared to the short-lived rotation in early-Jun, we expect the current rotation into value should last longer.

 

  • Growth might still outperform in medium-to-long term. In the medium term, however, such sector rotation has not yet been confirmed on RRG. We should not rule out the possibility of growth stocks keep outperforming value.

 

  • Tactical strategy: shift to selected cyclical stocks. Expect value/cyclical stocks to outperform growth stocks in the next few weeks. While we still like the secular outlook of growth stocks, in particular internet giants, we suggest making a tactical shift to selected cyclical stocks. How long would this rotation last depends on upcoming economic data, COVID-19 trend and vaccine development progress, U.S-China tensions, China’s monetary easing, among other factors.
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