Apparently, the US stock market after a long break for rampant growth, becomes selective again. Correction on it began relatively recently, in early October, but the turn in the priorities of investors came much earlier.
The graph above shows the ratio of two ETFs from Invesco: SPHQ (S & P-500 High Quality) and SPHB (S & P-500 High Beta). It can be seen that since the end of May, «quality» companies are far ahead of the «growth» companies. The term “quality” means those companies whose profits and dividends are more stable historically and therefore easier to predict for the future.
In addition, this leading dynamics of «quality» led to the fact that the ratio drew something like a «double bottom». And although this does not guarantee the mandatory continuation of the dynamics, it makes it more likely. However, with one important reservation for those who like to take everything literally and thinks only in short-term categories. A continuation of the forward dynamics of «quality» is indeed likely, but the goal indicated on the graph may not be achieved immediately, but by the end of 2019. If we talk about the short term, it may well be the opposite. That is, on the horizon of 1-2 months, a certain revenge from the companies of «growth» is not excluded — too quickly and too much they lagged behind the «quality».
The fundamental basis for the fact that “quality” can continue to outpace “growth” in 2019, in my opinion, consists of the following. For the last 3 quarters, the profits of US companies, on average, are growing regularly at a record pace compared with the same period in 2017 (+ 24% in the 1st quarter, + 25% in the 2nd and + 26% in the 3rd). This is achieved thanks to the growth of the economy, but, first of all, thanks to tax initiatives and incentives. And this is already in prices. It is still too early to talk about recession, but it is possible to speak about a slowdown in the US economy in 2019. Companies are experiencing «cost inflation», primarily because of record-breaking wage growth. In turn, this leads to the fact that companies are shrinking margins, and this is a sign of the close end of the cycle (although profits can grow further, but at a much slower pace).
We think that in 2019 this will lead to a certain shift in priorities and investor response to company reporting. While the market was unequivocally bullish, investors «encouraged» companies for good reporting much more than they «punished» for bad ones. Now it can change, and companies will be “punished” more than “rewarded”. In itself, this is neither good nor bad; simply, if we accept this as a hypothesis, then we should expect a higher variation in the dynamics of the shares of companies and higher volatility. Therefore, despite the fact that the medium-term growth of the US economy and the “health” of the business are not yet in doubt, it will not be as effective to buy and buy a “market” as before. Greater importance will be focused on the sectors, and sometimes even on individual companies, whose business is less cyclical and not as susceptible to short-term market changes.
That is why the ratio on the chart above has good chances for continued growth in 2019 (after some recoil in 2018). A graph is simply a visualization of the fact that investor interest will be concentrated in stocks of companies that are able to develop in any conditions, and not only in the most favorable ones. Of course, in the collapse scenario in the US market (which we don’t believe in now), everything will fall in absolute terms, both “quality” and “growth”. But «quality» in this case will not fall as much as «growth», and its relative dynamics in such a scenario will win even more.