Sweet Spot for Risk-On Stock Rotation May Be Near, Evercore Says

The long-awaited rotation to value stocks may finally be coming, according to Evercore ISI.

A combination of smooth re-openings, improving infection rates, high retail-investor cash levels and the historically extreme relationship between growth and value stocks all support conditions for a risk-on rotation in the next couple of months, strategist Dennis DeBusschere wrote in a note Monday.

“Another round of fiscal support and a treatment/cure are critical for a persistent value rotation,” DeBusschere said. “The next two months could be the sweet spot for that trade as a fiscal stimulus is likely before the end of July and the huma- ingenuity trade (vaccine/cure development) remains positive” in Evercore ISI’s view, he wrote.

Value stocks have continued their long period of underperformance against growth peers amid the Covid-19 market uncertainty. The Russell 1000 Growth Index is up 2.5% year-to-date, while its value counterpart is off 20%. Without a macroeconomic turn, the case for value stocks remains weak, Bloomberg Intelligence Chief Equity Strategist Gina Martin Adamssaid May 15.

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If reopenings remain smooth, it reduces the chance that a second wave of Covid-19 will cause significant economic disruption — which in turn boosts the medium-term economic outlook and increases the attractiveness of equities, DeBusschere wrote. It would also reduce credit spreads, causing stocks with lower credit ratings to outperform near-term, he added.

“The P/E spread between the top quintile of historical growth and traditional value stocks is extreme,” DeBusschere wrote. “Investors need to be prepared for a violent move toward value if there is better-than-expected economic news or development of a vaccine.”

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