Savita Subramanian, the Chief U.S. Equity Strategist at BofA Securities, argues that now is a great time for fundamental investors who have unlimited resources and time on their hands. The current investment climate is marked by a range of market phenomena, including demand patterns that mirror a recession, a boom in the services sector, leadership in early cycle sectors like homebuilding and late cycle sectors such as secular growth. Valuation disparities are at near record levels, which favors value investing.
However, she also points to the tendency of the cap-weighted index fundamentals to point towards narrowing, high multiple leadership with investors being drawn into Technology, Media, and Telecommunications (TMT) sector. The sentiment for risk-off was seen in December, however, it has now diminished. Duration risk has also been tackled in some of the largest tech companies through PE compression in 2022 coupled with cost cuts and buybacks.
Companies that were once cyclical but have been deprived of capital for the past ten years now display supply and capital discipline, and show promise in the form of potential efficiency benefits. Increased productivity investment is beneficial for valuations and returns, and it has been observed that gains in labor efficiency are met with lower risk premiums compared to gains achieved through financial engineering or cost-cutting.
The strategist suggests shorting bonds and taking a long position on beta. If the equity risk premium settles lower, Treasury yields may face upward risk. Demand for Treasury bonds from sources like the Fed, China, and Bank of Japan has diminished, and aspects of the U.S economy, such as debt to GDP ratio and political stability, are now more similar to emerging markets than developed ones. There are supply constraints in labor and commodities, which point towards potential for higher nominal growth and increased efficiency spending.
Despite Quantitative Easing (QE) leading to PE expansion in long-duration consumer discretionary and communication services, this did not extend to higher beta cyclicals. With regards to the ongoing credit cycle, more credit has been issued from regional banks and shadow lending as opposed to large, regulated banks. Instead of expanding capacity, cyclical companies have been paying down their debt. The biggest uses of capital have been buybacks and tech capital expenditure.
The correlation between the Senior Loan Officer Surveys (SLOOS) and S&P Earnings Per Share (EPS) has decreased from -65% before the Global Financial Crisis (GFC) to -35% post-GFC. The same applies to Credit Impulse (CI) and EPS, which has decreased from 55% to 5%. Sectors that were once sensitive to credit, such as Consumer Discretionary, Financials, Tech, and Communication Services, now demonstrate minimal sensitivity.
In 2022, private equity stepped in as a value investor during the bear market, with 100 U.S. public companies being taken private, a rate that was 70% higher than the usual run-rate. Although risk remains in certain assets like Commercial Real Estate (CRE) and some highly levered loans, Subramanian believes the size of this risk is known and can be managed. Credit conditions, according to their High Yield team, are just above the median, indicating normal conditions.
Make sure to take a look at the accompanying chartbook for all of the evidence.
by Savita Subramanian, Chief U.S. Equity Strategist, BofA Securities
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