29 Mar 2012

Market Update and Portfolio Strategy

Latest Economic Developments

Recent economic data came in weaker than expected. Flash PMI data from Europe and China showed weakness in the manufacturing sector, coming in at 47.7 and 48.1 respectively. A slew of US housing data ranging from starts to new home sales also came in lower than consensus expectations (Table 1).

Table 1ConsensusActual
New Home Sales325K313K
Existing Homes Sales4.61M4.59M
Housing Starts700K698K
Housing Market Index3026

Table 1: US Housing Data for February.

This spate of weakness has led to renewed talks about economic weakness. While investors took opportunity to book profits on such "disappointing" news, one needs to remember that a single data-point does not make a trend. Applying trend analysis on PMI or US housing data gives us a better perspective on the economic outlook. For example, US housing starts may have declined from the previous month and came in worst than expected, but the trend remains up since 2011 (Figure 1). So far, there is no indication of deterioration in global economic outlook and inter-market analysis confirms this.

Image courtesy of Stockcharts.com

Figure 1: Months of supply of homes at a new low.

Market Development

Within the equities space, we continue to see defensive sectors underperforming the markets (Figure 2) while cyclicals outperform (Figure 3). Even in Europe, financials are holding up even as equities consolidate (Figure 4). In the fixed income space, we find stability in the funding markets with TED spreads and LIBOR rates holding steady. Another sign that points to no deterioration of the global economic outlook is the performance of industrial metals. While it is still consolidating, it is holding up against precious metals (Figure 5), a sign that investors are not risk adverse.

Image courtesy of Stockcharts.com

Figure 2: Consumer staples, a defensive sector, continue to underperform the market.

Image courtesy of Stockcharts.com

Figure 3: Consumer discretionary, a cyclical sector, continues to outperform the market.

Image courtesy of Stockcharts.com

Figure 4: European financials holding up against the market.

Image courtesy of Stockcharts.com

Figure 5: Industrial metals holding up against precious metals.

Conclusion

The amount of negative chatter on markets is rising. We think this is healthy as it removes over-confidence and allows investors to focus on the fundamentals, rather than on hype and hope. Our view is that the outlook remains positive and markets signals are favourable towards risk. Expect the rally to continue once the consolidation/correction is over.

Portfolio Positions

No change to our current neutral to equity over-weights.



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