At the start of both 2014 and 2015, strategists’ outlooks and investor positioning belied a very strong consensus – expectations for improving economic growth supported a preference for equities over fixed income.
Government bonds were unloved as fund managers looked ahead to the prospect of US interest rate hikes. This year, the outlook for the US to lead the developed world in terms of both economic growth and monetary policy normalisation also created a strong consensus in favour of further appreciation in the dollar.
These expectations were dashed in 2014, a year that again highlighted the perplexing nature of recovery from financial crisis in a world that retains high debt levels.
These complexities manifested themselves in significant and unexpected swings in quarterly economic growth data, a mini-cycle effect created by higher sensitivity from consumers and corporates to changing economic conditions.
Yet, surprisingly, this had little impact on the ability of forecasters to reach another strong consensus 12 months later. Strategists’ views converged around unusually similar forecasts for US economic growth, bond yields and regional equity variations.
Consensus from confusion
Perverse though it may sound, we believe the very uncertainty of the overall environment is driving these strongly consensual views.
This is an elongated and abnormal business cycle in which investors must unravel a confusing mix of the familiar and the unfamiliar. Some economic variables and relationships seem to be behaving normally (eg unemployment) while others seem fundamentally changed (eg growth and productivity).
The Fed’s move to data-dependent policymaking adds a further complication, skewing the ‘normal’ relationships of cause and effect between economic indicators, monetary policy and market pricing.
At a time of such uncertainty we are seeing crowding in the relatively small number of assets/trades on which investors can build high-conviction investment cases.
When these trades are called into question, the unwinding of one-sided positions can create alarming sell-offs and market illiquidity.
The rotation away from mid-cap growth stocks in early 2014 was emblematic of this dynamic, which has also been evident in the violent sell-off in German bunds during the second quarter of 2015.
The combination of macroeconomic fragility and investor crowding means that contrarian trades can be extremely rewarding but should be employed judiciously.
Cases of crowding
During the first half of 2015, the widespread preference for equities over bonds was rewarded, albeit with significant volatility in the relative performance of different asset classes.
However, the drivers of this pricing environment have again been confusing, with economic growth data proving disappointing across many key economies.
Against this backdrop, here are some examples of where we can observe crowded positioning:
