The fear gauge for stocks is locked near its lowest levels on record, yet in an ironic twist, that very fact has led to one of the most anxiety-inducing situations in global markets.
In an environment starved for the types of price swings that create investment opportunities, traders have turned their attention to one strategy capable of generating returns in a motionless market: betting that those price swings will stay absent by shorting volatility. And that’s helped keep fluctuations at a minimum.
Sceptics will tell you that all is well and good with this approach — until the market gets hit with an unexpected shock, causing a painful unwinding for those crowded into the trade.
But, Kate Moore, the chief equity strategist for the Americas at BlackRock, which oversees $US5.4 trillion, thinks fears over a quiet market are overblown. To her, the low-volatility environment is a normal part of the ongoing cycle.
In an interview with Business Insider, the BlackRock equity expert spoke about the situation, while also offering thoughts on the red-hot tech sector, financial stocks as they approach earnings season, the Fed and the importance of companies across all sectors embracing new technology.
This interview has been edited for clarity and length.
Joe Ciolli: A lot of people are wary about the low-volatility environment, thinking that the market is too complacent, and that it could be caught off-guard. Do you agree with those concerns?
Kate Moore: We keep hearing questions about whether this is something to be worried about, or if it’s signalling something negative. The discomfort that people are feeling with low volatility feels unfounded to us. One of the things we’ve looked at is, in the long history we have of volatility, has low volatility in and of itself led to bad news for the market, or given a reason to be fearful. The truth is, we find that low volatility is actually the norm with an equity market, not the exception.
Given the fact that technology has often been the low-vol favourite, we’ve heard questions around if there’s a reversal in tech, will that mean the end of the low-vol regime? We don’t think that’s the case. We think it’s just a normal market rotation, and it doesn’t give us pause. But people should still be wary of narratives that any investment can never go wrong.
Bouts of high volatility, when they occur, tend to be very short-lived, and are very often good buying opportunities. They tend to be driven by significant changes in the macro or economic regime, especially when we’re moving into a period of expansion from a period of contraction.
Ciolli: Tech stocks also seem to be a major flash point in the equity market right now, as people debate whether they’re overvalued or not. Where do you come out on the spectrum? Are you bullish or more measured?
Moore: I take a more measured approach to the sector. I see a very strong opportunity over the medium term, but there are a few things in the near term that may not lead to a similar level of outperformance to what we’ve had in the past few quarters.
We all can agree that technology is the most favoured trade. The fact that it continues to be a significant overweight in equity portfolios with all different investment styles means that, if investors want to fund other trades and add to positions, they will have to likely fund that from tech. That’s what we’ve seen more recently — a technical pressure on the sector that has nothing to do with growth potential, earnings or balance sheets.
Ciolli: What’s your take on overcrowded trades? They can be good to the upside, but can also be painful when things go the other way. Are they bad, or can they be combated if you’re braced for it?
Moore: We need to think of the magnitude of crowded trades. If we see a small amount of crowding — like a one-standard-deviation move above the 24-month average — that doesn’t tell you much. If it’s two standard deviations above, then it’s going to raise a red flag. The magnitude of the rise is also something to watch.
Technology is a very consensus trade, and it has been for an extended period of time, so we don’t see it approaching an inflection point imminently. It’s deserved its ownership, both in terms of the results being delivered by the companies, and the potential it has to disrupt other sectors. At this point, it doesn’t seem to be at an outrageous extreme.
Ciolli: I keep hearing that financial stocks are set to benefit from the double dip of higher interest rates and looser regulation, yet buy ratings from single-stock analysts are fairly scarce. What’s your view on the sector?
Moore: Financials are still not a particularly well-owned sector. It looks to us like the Street is not even at a neutral position in banks. Because it’s not the most popular trade, and because we can see a sustained improvement in earnings and shareholder returns, it still looks like a very interesting sector. The performance that we’ve had over the last month feels justified, and that the catch-up was long overdue.
We have a constructive view on the macro, and this is critically important when we think about banks. In a sustained economic expansion, where we have a consistently firming labour market, which should eventually support some wage inflation and help credit demand, we think the Fed will stay on track in terms of normalization. If that’s your belief, you should expect that this modest rate increase that we’re getting will not only be good for the economy, but also good for demand and the bottom line of bank stocks.
We find that banks are much slower to pass along higher rates to depositors, so every incremental hike in rates goes directly to the bottom line. We’re also seeing banks getting more conservative about lending. I also feel super encouraged by the stress test results, and the cash return strategies that we expect banks to pay out. And valuations are not stretched. We’re close to the five-year average for US financial stocks, while other sectors have re-rated.
For me, it checks all the boxes. It has a good macro story. It has a good fundamental story that will improve on the back of the macro, both from a policy perspective as well as for demand for financial services. You don’t have any valuation roadblock. And you have positioning and sentiment that doesn’t look extreme. It’s very hard for me not to like the sector.
Ciolli: Some people have criticised Fed hawkishness by saying we’re not close enough to our inflation target to raise rates. What are your thoughts on what the Fed has done and looks to be doing?
Moore: We’re all talking normalization instead of rate hikes. If you think back to a few years ago, when we were first approaching the prospect of taking rates off the zero lower bound, everyone was talking about rate hikes. And now everyone has come to accept that it’s actually normalization, as opposed to something that significantly tightens financial conditions.
It’s also important to note that through the last few rate hikes, we’ve actually seen financial conditions loosen, and that’s an important consideration for the Fed. They don’t see us at a place where the market is particularly stretched.
Even though we’ve had a softer patch for inflation, that shouldn’t hold the Fed back from normalizing, especially if we continue to get a small amount of wage inflation. Our view is that if the labour market continues to tighten, then we’ll see that wage inflation come through a little bit more by the back end of this year and into 2018. But not to such a degree that it becomes a huge burden for companies.
It feels like we’re in a sweet spot where growth is strong enough that we can normalize policy a little bit, but it isn’t so strong that we’re talking about a tightening cycle instead of a normalization cycle.
Ciolli: Amazon has been making some big deals and throwing its weight around. It seems like the landscape of retail is really changing. What are your thoughts on the sector?
Moore: The consumer sectors in general are really a story of haves and have-nots. It’s those that leverage technology, and those that don’t. Those that don’t are being correctly punished by the market. Their business model hasn’t adapted, and it’s fair to say that they probably don’t deserve any kind of premium valuation, or strong amount of ownership.
What we’ve seen in terms of the recent deal flow is companies with strong assets and broad consumer bases trying to strengthen their assets and broaden those bases even more.
We all need to step back and assess what disruption we’re seeing from technology across a wide range of sectors. Tech is also disrupting oil production, the way people work and the labour force, manufacturing and production, healthcare services, and price discovery across all markets. In every sector and industry, the haves and have-nots need to be separated out.
Ciolli: Are there any specific sectors that you favour? Dislike?
Moore: Financials, as you probably gathered from my enthusiasm in previous comments, is the sector I’m paying very close attention to. Expectations have come down for second-quarter earnings, based on the top trading comps. The yield curve has flattened, and we’ve had just OK credit growth. So we may have interesting buying opportunities, depending on how the numbers come out. I’m staying constructive on financials.
I like tech over the medium term. But keep in mind it’s subject to continued rotation, because it will be the funding source for other trades.
Another sector I like is healthcare, but much more on a stock selection basis. Performance year-to-date has been stronger than I expected, in aggregate, but I do see real opportunity for certain industries and specific stocks to perform well in the medium term. Some of these stocks are going to perform well through multiple different parts of the business cycle.
The contrarian in me would love to gobble up energy stocks. But we’re seeing massive technology disruption, and even if we think there’s going to be a better supply-and-demand balance on a global basis, innovation is reducing the cost of production. From that perspective, you’d have to be very selective. And it trades so much on macro factors like oil prices that it’s difficult for me to hunt around there.
Another sector on watch for me is industrials. Performance has been strong this year, and there was a huge amount of enthusiasm after the election that obviously hasn’t come true. There’s a longer time horizon for that, but there are still companies in the sector doing very well given where we are in the economic cycle. But we still need to see how sustainable that is. It’s more of a neutral position.
Ciolli: More philosophically, what’s the best piece of advice you can give to an investor just starting out right now?
Moore: The number one thing that’s contributed to my career and professional development has been flexibility, both in terms of career decisions and my investment process.
The industry has changed very dramatically during the time I’ve been in it, and it feels like the pace of change is only increasing. For young people in the business, I’d avoid trying to over-architect your career path. Some of the best career opportunities come when there are moments of change. And professional growth occurs when you’re willing to pivot. Being well-rounded and flexible about job opportunities is very important.
In terms of my investment process, it’s changed a lot throughout my career. You have to be willing to incorporate new information and data sources, and understand that the way you analyse things will have to change over time. It’s also critical to acknowledge when you’re wrong, whether that’s changing your view, closing your position or adopting a new approach. Be flexible. Don’t consistently try to analyse investment opportunities the same way.
I also try to be a sponge and absorb information about everything, even things outside the world of investment. The best investors are those that have a great understanding of history and behaviour. You really need to understand what makes people tick.
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