Country Trumps Sector

Thursday, January 18th, 2024

Switching between equity regions will be a theme in 2024

Our models do not currently identify much opportunity for generating outperformance by switching between asset classes and most of our equity sector models are reducing their recommended active weight. We still think that above average exposure to cash and short-dated bonds is a good idea. However, they may be some opportunities for switching between equity regions, which will be affected by changing perceptions of political risk as we move through the year. The important thing is to stay nimble and remember that other people have opinions too. One example of this is in EM Equities, where India vs China is now priced for perfection, which doesn’t reflect the fact that India has a general election in April or May.

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Stall Speed

Monday, October 23rd, 2023

US equities may be on the verge of a short-term correction

One of our key indicators for US equities is flashing amber. The recommended weighting when compared with a portfolio of 10-year Treasuries and cash has fallen to a level where it historically continues down to zero more often than not. This could be accomplished by a correction in equities or a rally in bonds – very probably a mixture of both. However, we are more optimistic about the medium-term future. We don’t think this correction would indicate an upcoming US recession. It’s very difficult to have one, when the Federal budget deficit is over 6%. In our view, the correction in equities is a necessary pre-condition for putting a short-term floor under the Treasury market.

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False Sense of Security

Monday, July 10th, 2023

7-10 year Treasuries offer no hedge against equity declines

We are mystified by the ongoing strength of the long end of the US yield curve. We fully acknowledge our bias towards a higher-for-longer view of inflation. Even so, we don’t understand why investors are willing to put up with lower yields and higher volatility than they could get by investing in shorter-dated Treasuries. Over the last 18 months, 7-10 year US Treasuries have delivered absolutely no protection against a decline in US equities. In fact, they have a tendency to decline at the same time and this downside beta has been getting worse. The same relationship affects all Treasury maturities from 1-3, all the way out to 10-20, but the 7-10 year index has the worst beta.

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Some Safety Plays May Not Work

Friday, April 7th, 2023

Positive correlation between equities and bonds still a threat

The top-down consensus is rightly gloomy about the outlook for earnings estimates and equity benchmarks in the US. The problem is that the market shares this analysis and still refuses to go down. We need an additional catalyst to shake us out of the current trading range. A mild US recession is not the main risk to balanced portfolios, provided bonds rise while equities fall. What we worry about is a bear market in everything, if the current regime of positive correlation between equities and bonds continues. There are ways to mitigate this, by lowering the beta in your equity portfolio, increasing exposure to Europe (and anywhere else that may benefit from a weak dollar) and increased exposure to cash and money market funds.

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The Case for Europe

Friday, January 20th, 2023

Currency, sector orientation and valuation are all favourable

The basic argument in favour of European Equities is that three of the largest sectors in the index, Financials, Industrials and Consumer are ranked in the top three in our models – unlike the situation in the US, where Technology is in the bottom three. All three have forces driving their outperformance which should last most of this year (respectively rising interest rates, re-opening of global supply chains and rearmament, and post-pandemic recovery). The region, its currencies and its equity markets were priced in October for a catastrophe which simply hasn’t happened, and which is now very unlikely. There may be some short-term profit-taking, but the excessive valuation discount and the currency misalignment will take longer than a few weeks to unwind.

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Weak Tech, Weak Dollar

Friday, January 13th, 2023

Welcome to the new regime, which could last a long time

Our models don’t like US Equities or US Treasuries and they don’t like the dollar either. This is an unusual set of circumstances, but one which we think we can explain. The key is to understand the relationship between tighter US monetary policy, lower valuations for mega-cap tech and the unravelling narrative of US exceptionalism. US Bond yields may be rising, but yields in other currencies are rising faster. We strongly recommend that investors reduce their exposure to US Equities and increase their exposure first to Europe and then later to Emerging Markets.

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Santa’s Merry Massacre

Friday, December 2nd, 2022

What Santa gives the New Year can take away

Recent strength is US and global equities is entirely consistent with normal seasonality, particularly the outperformance of the Eurozone. If normal seasonal patterns prevail, we would expect many of the recent trends to reverse in the New Year as follows: US equities will give up recent gains, Eurozone equities will underperform, US Technology will suffer further declines and the US dollar will strengthen once again. All of this would be consistent with normal seasonality, as is our new call that the bottom of the bear market will not come until Q3 2023 at the earliest.

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Bear Market Sector Strategy

Friday, November 4th, 2022

What to focus on and what to ignore

It easy to be overwhelmed by the speed and quantity of information in a bear market. Investors need a clear focus on what matters and what doesn’t. In any bear market, there are about 10 sector pairs (out of 45) which really drive the performance of a regional equity portfolio and the rest don’t matter very much. These pairs vary from one bear market to the next but are relatively easy to identify. There is also another set of pairs, which may be significant in market cap terms, whose relative performance cannot be easily integrated with the rest of the portfolio. US sectors which feature heavily in this list in this bear market include Financials, Healthcare and Industrials. In Europe, they are Materials, Utilities and Financials.

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Pivot to Asia

Friday, July 22nd, 2022

It may be the least-worst option

There is a leadership vacuum in global equity markets. The US, the Eurozone and the UK all have serious issues to confront, ranging from valuation excess and monetary tightening to political uncertainty and energy rationing. Japan and Emerging Asia share some of these problems but are not as badly affected. One is a low return, risk reduction trade, while the other offers high risk and high reward. Both strategies have a place in a well-diversified global equity portfolio.

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Estimate Breadth

Friday, July 8th, 2022

The raw data look reassuring but the trends aren’t

The percentage of companies in the S&P500 with no drawdown in their earnings estimates is declining and just about to drop below its median for the last 15 years. The percentage where there is a drawdown of more than 20% is about to start rising, but from a low level. We are still within normal ranges on both measures, but if they move out of this, the downside is significant and the recovery takes much longer than the decline. At the sector level, we cannot make sense of the relative rankings in several cases. In particular, we think the consensus is far too optimistic about the outlook for Industrials.

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