Some interesting thoughts here from BofA quant strategist Savita Subramanian on what will work, investment-wise, during the next market cycle.
Her basic argument: ever since the tech bubble, the leaders have been credit-reliant companies, and consumer-oriented companies whose business models are predicated on cheap credit.
In the next leg, the winners will be companies with strong balance sheets (like tech) who don’t need low interest rates to thrive.
Since the Tech Bubble, highly levered companies, credit-driven sectors, low quality and smaller capitalised stocks — all of which thrive on access to inexpensive capital — dramatically outperformed the market until the Financial Crisis — and generally resumed their upward trends since 2009. Stocks with exposure to US consumption also generally outperformed as low interest rates stimulated consumers to spend rather than to save. And valuing companies on equity value — stock price-based valuation measures — generally yielded superior backtest results than valuing companies on firm or enterprise value because equity-based valuation measures inadvertently rewarded companies with higher debt burdens. In short, leverage was rewarded and liquidity was penalised. But we caution investors that these results may not be representative and could be simply an artifact of the “one regime” market we have been in since our data began.
For the next cycle, just do the opposite
At an asset level, we believe bonds with prices inversely related to rates, could suffer, whereas equities — in particular, beneficiaries of rising rates such as Tech and Industrials — are likely to fare better in an increasing interest rate backdrop. Larger companies with strong balance sheets require less capital to survive, and could outperform smaller or more leveraged companies with limited access to inexpensive capital. Higher quality companies (by earnings volatility) that have seen little to no multiple expansion during the past 10-20 years of hyper-stimulus could re-rate higher, whereas companies with volatile earnings that have sold at persistent premiums could experience multiple compression, in our view
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