Tuesday, June 11th, 2013

Broad Brush

The equity market turbulence of recent weeks has left investors feeling nervous, especially as bonds have also fallen over this period, so they cannot fall back on the classic “equities down / bonds up” relationship. We look at our sector rotation models to see (i) how they have changed over the last four weeks and (ii) whether they can offer any clues about what lies ahead.

This has to be a broad brush exercise otherwise it would take far too long. We will only consider ranking rather than portfolio weights, and we will not spend much time on the direction in which our probability curves are likely to move. We look at five regional models covering Japan, the US, the UK, Pan-Europe and the Eurozone and an overall ranking which is the simple average of the regional ranks. There is no adjustment for market cap or currency. It’s crude but it’s quick, and investors need answers now, even though the answers may change as market conditions evolve.

Propping up the bottom of the table are the Materials and Energy sectors. Materials, which comprises Mining and Chemicals, is bottom in the UK and Pan-Europe and 7th or 8th in the other three regions. The greater the exposure to Mining rather than Chemicals, the more likely it is to be lower down the ranking. Energy comes 10th in Japan and 8th or 9th everywhere else apart from the US, where the euphoria surrounding onshore shale gas clearly has an impact. The overall ranking of these two sectors is unchanged over the last four weeks: Energy is 9th and Materials is 10th.

Financials has relinquished its place at the top of the table and is now ranked 2nd overall. It was 1st in Japan and 2nd or 3rd in the UK, the US and Pan-Europe, but it has now slipped to 2nd in Japan and 3rd in the UK and Pan-Europe. There is clearly potential for further slippage in these regions, but the situation has actually improved in the US, where it is now ranked 1st again.

The new overall number one is Consumer Discretionary, which has improved its ranking in every region apart from the US, and is ranked 1st in the UK, Pan-Europe and Japan. US economic growth is so strong that the Fed needs to consider tightening policy, while Japanese growth is so weak that the BoJ must loosen dramatically. Apparently both scenarios support the outlook for consumer spending, according to investors. The same logic seems to imply to Industrials, which is ranked 3rd overall, and which has seen its ranking improve in the UK and Pan-Europe.

There is no evidence so far of any wholesale rotation into defensive sectors, apart from Japan. Telecom and Utilities are ranked between 6th and 10th in every region outside Japan, and have gone nowhere. Four weeks ago Consumer Staples was ranked 5th in most regions, but now it has lost ground in the UK, Japan and the Eurozone.  Health has maintained its overall 4th rank, but there are diverging trends. It has gone from 8th to 4th in the UK, but from 3rd to 9th in Japan.

And finally we come the great diverger, Technology. Four weeks ago it was ranked in the bottom two in Japan and the US and in the top three in the UK, Eurozone and Pan-Europe. Now it is ranked between 4th and 7th in all five regions, gaining where it was low and losing where it was high. As ever in this sector, there are a myriad of stock-specific reasons behind each move, but taking everything into account it has moved up the overall ranking, not down as we would expect if fear was the dominant emotion.

We draw three main conclusions. First there is no appetite for energy or commodity exposure in any region, which is consistent with our view that Emerging Market equities and bonds remain unattractive. Second, outside Japan there is no evidence of any knee-jerk rotation into defensives, although there is evidence of a move away from Financials. Third, investors seem willing to stick with the economic recovery theme, based on an increased ranking for Technology and Consumer Discretionary and no overall change for Industrials.


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