Eight Non-Consensus Views

Monday, December 19th, 2022

A bearish consensus can still be complacent

We agree with the idea that US equities are going to suffer in the New Year, but disagree with many of the assumptions surrounding this view. We think US Treasuries are behaving like a risk-asset and cite their current elevated volatility as evidence. We highlight the positive correlation between equities and bonds, which means that there we may well repeat the bear market of everything we saw in H1 2022. On this basis, the dollar strengthens temporarily and the trough in equities is delayed till Q3. When the recovery comes, sectoral and geographic leadership in equities in likely to change and China will be a much bigger part of the story than Western investors currently imagine. The outlook for oil is anyone’s guess, but it will influence inflation expectations and generate bursts of volatility in all markets, contrary to its current benign behaviour.

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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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Switch Off the Autopilot

Friday, October 7th, 2022

Currency impact on equity allocation is now extreme

The strength of the US dollar has hugely overstated the attractiveness of US equities to both US and international investors. The currency effect against developed markets is more powerful than it has been in all but 3% of weekly observations, going back to 1995. This is fine while it lasts, but one day it will go into reverse. Meanwhile, the dollar index is approaching generational highs. After the last tech-bust and peak dollar, US equities underperformed the rest of the world, in dollar terms, for the next five years (2003-08).

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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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Lower for Longer

Friday, June 24th, 2022

New worst-case scenario for US Equities

We have cut our reasonable worst-case estimate of where the S&P500 may bottom from 3,400 to 3,000. This follows on from our last note which argued that current consensus earnings were likely to drop by at least 15% before hitting their trough sometime in 2023. Our new target implies a forward pe ratio of about 15x, which is slightly lower than the median for this century.  As consensus forecasts are reduced, we expect the earnings mix to move away from highly-valued sectors like Tech and Consumer Discretionary towards lowly-valued sectors like Energy and Materials. The other reason for our new target is that nobody has any profits from other investments which they can reinvest into equities. US 7-10 Treasuries are down by about 17% since the equity market peaked, compared with gains of about 10% at the equivalent stage of the bear markets in 2001 and 2008.

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How Earnings Recessions Behave

Friday, June 10th, 2022

Consensus estimates aren’t reliable in a bear market

Bear markets can make the most rational of investment approaches look pretty stupid. Any concept of fair value based on consensus estimates can be downright dangerous. The typical delay between the peak in the index and the peak in estimates is more than 30 weeks, so we should not expect the consensus to start cutting until late August.  The typical drawdown in 12-month forward estimates lasts between 115 and 170 weeks. So, the estimates you are using for 2022/23 may also be the numbers for 2025/26.

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Go Direct

Friday, April 29th, 2022

Compare equity sectors against Treasuries, not other equities

We think US equities as an asset class are going to struggle against US Treasuries over the next few weeks, partly because bonds have already priced in a lot of bad news, and partly because earnings estimates for 2022 and 2023 are too high. It may take investors some time to realise this, so positioning within equities or between equites and bonds may give rise to significant timing difficulties. However, our models are really clear about the relationship between Treasuries and some sectors, like Energy. There are at least four of these sectors now and this number could rise to eight. Investors may find that using this direct approach, comparing equities against Treasuries, rather than other equities, helps to clarify their thinking.

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Three Quick Ideas

Friday, September 10th, 2021

End of summer lull makes us cautious about big calls

We are always wary of making big calls on the basis of thin summer markets, so here are three quick ideas. First, Japan produced an important technical buy signal just before Prime Minister Suga announced his resignation. It is very similar to the one at the start of the Abenomics rally in 2012. Second, the recommended weight of US equities to the rest of the world is at a 10-year high and it does not normally hold this level for more than a month. Third, we think European industrials are out of line with US Industrials and potentially vulnerable.

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China vs US Exceptionalism

Friday, August 27th, 2021

Exposure to some sectors may be justified but timing is critical

Our recommended exposure to Chinese equities is effectively zero, but EM Equities (of which China is by far the largest part) are critical to the success of any global balanced portfolio. So, we have looked at individual Chinese sectors to see which ones have been the most successful diversifiers compared to their US counterpart. The good news is that it is easy to identify those which fail the test badly: Financials, Industrials, Telecom and Small Caps. The bad news is that only Technology has offered successful diversification over the whole of our test period, but now is not a good entry point. There may also be opportunities in Consumer Staples and Healthcare, but, again, we prefer to wait for a better entry point.

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A Difference of Opinion

Friday, July 2nd, 2021

What ESG may mean for the Energy sector

US investors are significantly more positive about the Energy sector than their European counterparts. There could be many explanations, but we are increasingly concerned that there is a buyer’s strike in Europe. This could have unintended consequences – first of all for the implementation of a low-carbon style on a global basis, and second on the outlook for inflation in 2023 and beyond. Changes in our investment style in Europe may have moved too far in advance of changes in our lifestyle.

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