It’s ‘Go Time’ for the Riskiest Equities Thanks to G-20

(Bloomberg) -- Investors just got the green light to play offense.

The Group-of-20 detente between the U.S. and China is feeding the green shoots of an equity rotation to riskier and more cyclically-oriented shares. The S&P 500 Index climbed to a record high on Monday after President Donald Trump agreed to ease a ban on American companies supplying Huawei Technologies Co.

It's “go time in equities with ‘high beta' grab-in across cyclicals likely thanks to the trade truce glide path,'' wrote Charlie McElligott, cross-asset strategist at Nomura Securities.

Investors appear to have been sniffing out the potential for an about-face in the equity landscape. Despite an extreme penchant for defensive equities in a world of slowing growth and clashes over cross-border commerce, cyclical stocks such as industrials outperformed in June -- notably in the week leading up to the meeting between presidents Trump and Xi Jinping.

The relative performance of riskier shares was driven by a sinking greenback, rather than tumbling yields. A weaker dollar tends to provide a bigger benefit to equities that are more sensitive to global activity.

Risk-averse investors observing the loss of momentum in safe stocks now have some fundamental reasons to change course, with the hope that it's always darkest before the dawn for global growth. Expectations that the Federal Reserve will cut rates are a boon to not just U.S., but also to global activity. Meanwhile, worst-case scenarios in the U.S.-China trade war have been averted.

This changing mood music around trade, for now, is poised to overwhelm indications that the global economy is still failing to find its footing.

“Accommodative central bank policy, easier financial conditions, a strong U.S. labor market, and elevated margin sentiment support multiple expansion and cyclicals relative to defensives,” Dennis DeBusschere, head of portfolio strategy at Evercore ISI, wrote in a note to clients.

Over two-thirds of cyclical stocks have advanced over the past three months, and the share of defensive equities outperforming has turned negative, according to DeBusschere. That's a “concerning trend” for safe stocks, and “especially so given the group's elevated price-to-earnings relative to cyclicals.''

Christopher Harvey, head of U.S. equity strategy at Wells Fargo, warned about the unsustainable strength of low volatility early last month, when the group's outperformance reached levels comparable to 2008. Because of that, he upgraded energy equipment and services in June while downgrading real-estate investment trusts. Harvey also recommended financials as a cheaper low volatility option.

“The only thing that doesn't make it a disaster for low vol is the fact that people think the Fed's going to cut and that should keep the 10-year relatively contained, but I think we'll see a continued unwind of that trade,” he said in a telephone interview. “The way the G-20 has played out is good for the ‘global reflation trade' -- you've got to believe that semis and capital goods start to go here.''

--With assistance from Justina Lee.

To contact the reporter on this story: Luke Kawa in New York at lkawa@bloomberg.net

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Rita Nazareth, Brendan Walsh

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