The Great Rotation: misnomers, misunderstandings and mistakes
Henning Stein, PhD, GCB.D
Results-Oriented Investment Solutions Executive | Certified Board Member | Asset & Wealth Management Change Agent | International Presenter & Author
Movement en masse
Herd mentality has always been rife in the investment world. Sometimes it offers a satisfying reflection of the wisdom of crowds. Sometimes it provides unhappy evidence of the blind leading the blind.
Right now, spooked by a number of macroeconomic factors, the herd is rotating. Many investors are selling out of tech, the dominant sector throughout the worst of the pandemic, and moving into areas more obviously associated with broader economic recovery.
In other words, we are witnessing a rotation from growth to value. The reasoning behind this shift, which has long been touted and now looks to be in full swing, seems straightforward enough.
Many tech stocks, especially those in the small-cap and micro-cap arenas, are probably years away from generating the bulk of their cashflow. They are also likely to experience marked volatility in the face of inflation and rising interest rates. This makes their potential earnings tricky to calculate.
By contrast, the historically dependable likes of industrial and energy companies have renewed appeal. Ditto banks. With the Omicron variant of COVID-19 proving less of a threat than its predecessors, travel and leisure businesses are also regaining attention.
All this appears to make sense, but does the sweeping switch now taking place – the Great Rotation, as it has rapidly come to be known – really represent the best course of action for each and every member of the herd? I suspect that what we are seeing underlines that a “one size fits all” ethos very rarely – if ever – applies to investing.
Definition and delay
Without wishing to become mired in basics, it is first essential to define what “rotation” means in a context such as this. On the whole, the term is employed to describe a situation in which investors move in unison from one sector or industry to another – as is occurring now.
Fittingly, rotations are linked to cycles. These can be economic, stock-market-related or driven by the overbuying or overselling of certain shares. Ideally, investors rotate when they anticipate a decisive change in a cycle.
The key word here, I would argue, is “anticipate”. Strictly speaking, as language pedants are quick to stress, “anticipate” has a very particular meaning. To anticipate is not the same as to expect. To anticipate is to take action before something happens.
This presents a problem to those currently contemplating joining the dash from growth to value, because the fact in this instance is that the relevant something has happened already. In recent weeks, most notably in the “spec-tech” space, some stocks have suffered losses deep in double-digit territory.
So this is now hardly a case of anticipating – unless, that is, we are content merely to anticipate further declines. Getting out of tech before any damage is done is no longer an option. That ship has sailed.
Hindsight is a wonderful thing, of course, but the reality is that the best time to exit growth and head into value would have been before macroeconomic factors rocketed up the global agenda. Doing so now, when many high-growth stocks have already endured a battering, might be viewed as not just tardy but foolish.
Standing back from the stampede
Let us assume, as seems reasonable, that the impact of future hikes in interest rates has by now been priced in. In turn, let us further assume that growth is set to remain out of favor for several quarters – possibly until the end of escalating rates and quantitative tightening alike.
Given this ostensibly bleak scenario, are there any options beyond accepting a hit and rotating out now? Herd mentality and a “one size fits all” philosophy suggest that the stampede into value is the only game in town, but it is not outrageously difficult to conclude otherwise.
Take, for example, the role of investment horizons and the strategies arising from them. By way of a simple illustration, let us imagine two investors: A, who has a horizon of less than 12 months, and B, who has a horizon of more than half a decade.
With a comparatively short timeframe, A might choose to hold firm until the unfashionable denizens of the tech sector experience a recovery of sorts. This would entail selling out and moving on if or when things pick up, albeit with a loss still the likely outcome.
Meanwhile, B might elect to look significantly further ahead and allocate more to growth. This approach would require carefully exploring bottom-up opportunities, with the relationship between free cashflow and enterprise value uppermost in any analysis. Imminent earnings reports and Federal Reserve announcements could help inform such a decision.
The point is that neither A nor B would inevitably benefit from leaping aboard the rotation bandwagon – not least now that the fundamental goal of anticipating a change in the cycle is unattainable. Irrespective of how loud the “noise” might be, knee-jerk responses are rarely as effective as pausing to think.
Rotation versus embarkation
This brings us to a last observation about the niceties and nuances of rotation. With the crucial issue of asset allocation in mind, the question of precisely what investors should rotate out of is vital – not to mention intriguing – in the current climate.
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We know that the prevailing narrative urges a rotation out of growth. Yet we have also seen that this could be counterproductive for many investors, who would at best be plunged into a damage-limitation exercise.
I would therefore contend that value today is not necessarily attractive to those rotating out of growth. Rather, it is attractive to those rotating out of cash – which is to say that it is attractive to new money.
We might add at this stage that moving from cash to value is not the stuff of rotation in any event. After all, new money has only just clambered on to the merry-go-round; moreover, the likelihood of eventually moving back into cash is unlikely to feature in some kind of cyclical masterplan.
So the Great Rotation, all things considered, might actually be something of a misnomer. It is also very likely a source of misunderstanding and, alas, mistakes. There is no doubt that it suits the needs of many investors, and I do not seek to pretend otherwise; but to blithely suppose that it suits the needs of all is quite wrong.
Ultimately, every investor has unique requirements and preferences. Asset and wealth managers persistently trumpet this message, and we would do well to push it with renewed vigor as the clatter of the herd’s hooves becomes ever louder.
Disclaimer: The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment-making decision. As with all investments, there are associated inherent risks.
Links
Financial Times: “Investors dash out of US tech stocks in powerful market rotation”
Bloomberg: “Drubbing in tech stocks marks biggest rotation to value since ’95”
Bloomberg: “Wall Street hails the Great Stock Rotation”
Tom Chivers: “Expecting the misuse of the word ‘anticipate’”
Financial Times: “Spec-tech is getting wrecked”
Nasdaq: “Earnings calendar”
Markets Insider: “The stock market has been flipped upside-down in 2022”
Non Executive Board Member
2yGreat read - thx Henning
Global Development Program│Public Policy Consultancy at ANBOUND
2yThanks, Henning. It's insightful. If the demands do not keep pace with increasing investments, there is a sense of overspeed market. When swollen capitals flow into technology that is not always good for well-being but intendedly widen the social gap and inequality. Then, it's timing for investors to make a rotaion. Hope to further discuss and meet you in Europe or Asia at earliest 2023.