Invesco’s chief investment officer has said valuations of defensive stocks are vulnerable to a drastic change which he claimed is about to shake-up the markets.
Nick Mustoe, chief investment officer of Invesco Perpetual, pointed to the pressure imposed on governments to speed-up the shift away from current monetary policy towards pro-growth fiscal policy.
This, he said, has profound implications for markets, pointing to the increased prospect of a steepening yield curve in fixed income markets, as falling bond yields are no longer the norm.
Mr Mustoe said this also has significant implications on defensive parts of the equity market, known as ‘bond proxies’.
“Such stocks have performed incredibly well in recent years, but they have been loved not because of their fundamentals but because of their low level of expected volatility; in essence their ‘bond-like’ qualities."
He said: “Valuation as a driver of returns has been forced to take a back seat.”
But he said we are now in a situation where many stocks that are perceived to be ‘defensive’ are now very expensive compared to their historic valuations.
Mr Mustoe said such valuations are unsustainable over the long-term and will render these parts of the equity market vulnerable with valuation returning to the field as a main driver of returns.
“As valuation reasserts itself, we could see a ‘great rotation’ out of supposedly ‘defensive’ equities.
“In fact, we have already seen a meaningful change in the internal dynamics of the equity market since the summer, as investors rotated out of bond proxies into hitherto unloved cyclical areas of the market that tend to do well when the economy is stronger.”
The Invesco investment head said there is “plenty of scope” for that rotation to continue as fiscal policy comes into the picture.
Mr Mustoe also echoed a point made by Invesco's head of US equities Simon Laing last month about the impact the US election had on markets.
"The election victory of Donald Trump has already steepened the yield curve somewhat, managing to do in three days what the US Federal Reserve has not been able to achieve in years.”
katherine.denham@ft.com
