U.S. stocks may be approaching their high-water mark, but beneath the surface of this year’s rally is a tide of unease.
For quant and fundamental investors that slice and dice equities based on their characteristics, the 2019 rebound brought with it a conundrum.
A toxic combination of fickle trends and macro angst is making factors -- investing based on share attributes like profitability and market capitalization -- behave in similar ways. At the same time, this cautious rally has juiced safer stocks offering low volatility or healthy fundamentals, making defensive assets pricey.
It’s a headache for asset allocators of all stripes.
“The market isn’t going up because of cyclical reasons, the market is going up because there’s no alternative in bonds,” said Lode Devlaminck, managing director of global equities at DuPont Capital Management. “We’re in a mechanical bull market, not a growth bull market.”
Nonetheless, the firm is trimming quality allocations, alongside exposure to growth shares, in favor of more beaten-down alternatives.
That’s because quality stocks, boasting facets like strong balance sheets, have gotten expensive. The style’s valuation relative to the benchmark is near a record high, according to MSCI indexes going back to 2013.
It dims the appeal of defensives, even as fears for the economy continue to swirl.
“It’s better to be diversified, which helps avoid crowding risks,” said Jonathan White, head of client portfolio management at the $22-billion quant equities arm of AXA Investment Managers. Investors should “actively select quality stocks to avoid the most expensive areas,” he said.
At the same time, elevated volatility and correlation across factors is making it harder to isolate and profit from particular style exposures, according to Evercore ISI.