Portfolio Manager John Fujiwara explains why he believes conditions are ripe for a rotation toward previously out-of-favour value and cyclical stocks and why he expects the shape of the yield curve to hold significant clues about the state of the economy.

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Where do you see risks and opportunities in markets in 2020?

John Fujiwara: We see extraordinary opportunity to rotate out of crowded long positions in low vol defensive and momentum stocks into cyclical value and maybe even high-beta stocks going forward. So we see evidence of the crowding of these positions through historically wide valuation spreads, even high investor leverage levels and the near abandonment of cyclical value sectors, such as energy. Additionally, kind of similar to that, we think there is opportunity in commodities, especially if the last few years of zero to low interest rates can somehow stimulate global economies going forward, all at a time when production capacity has been reduced due to low demands and low prices for hard commodities or real commodities or real assets such as energies and industrial metals.

Which macroeconomic themes do you think will be the most relevant in the year ahead?

Macro themes that are relevant, the US-China trade war negotiation is… it is hard to say that it doesn’t touch everything. I think interest rates will also play a big role as well as the shape of the yield curve, the steepness of the yield curve, so global yield curves. Another theme that could shape up to be important is whether or not global economic activity has actually bottomed. So as represented by global PMIs, it will be interesting to see whether or not PMIs bounce from here and we have hit the bottom and we are now going to start to go up again or whether or not we are pausing to make just another low here in the near future, so that is a theme that is very important.

What surprises did 2019 present?

Two surprises that I really thought affected me in 2019 was first, the realisation of how quickly Fed policy can totally shift. If you recall, one year ago in December, they were tightening policy, probably about one year ago right now. And within a month, they had shifted their rhetoric to dovish, probably, of course, based on the sell-off in equities at the end of last year. So these movements, this dramatic shift in policy, can cause asset prices to swing dramatically as well as change investor behavior as far as what sectors they want to be in. So I think the quickness of how they shifted has been something that I have never seen before in 30 years of investing. So I think that that was a surprise to me. The second was the protest in Hong Kong, which reminded me that geopolitical events can have profound impact on the financial markets. What is a relatively localised event in Hong Kong has had a very big effect on investor perceptions of the region in general and has been an effect on how people perceive China and even Korea and other countries in that area.

Which market or economic indicators will be important to watch in 2020?

I think that investors tend to assimilate data pretty quickly and their thoughts are reflected very quickly in yields. So I think that the most important thing is to watch the yields, and so charts on yields and yield curves. I think that that will tell you a lot about people’s perceptions about inflation, about economic activity and maybe even the credit worthiness of sovereigns that are now having to consider increasing the amount of issuance to the debt market to possibly fund fiscal stimulus.

 

Cyclical stocks are generally more susceptible to changes in the macroeconomic environment and may be subject to greater volatility. Performance is often tied to the economic cycle, with stronger performance during period of economic strength and vice versa.

Purchasing Managers’ Indexes (PMI) are economic indicators derived from monthly surveys of private sector companies.