29 Apr 2013

Macro Strategy Update

Market Update

Over the past couple of weeks, markets appear to be running on fumes. The economic data has been worse than expected and some have deteriorated, yet equities appear to be holding up well.

Europe is a prime example. It seems to be falling into another recession, judging by how the PMI numbers continue to stay in contraction zone. Even the mighty German manufacturing sector fell into negative territory, according to the latest flash PMI for April1. More worrying is the latest ifo survey, which showed a second consecutive month of decline in business expectations and conditions2.

Yet when we look at market performance, we see European equities recovering from its early April losses. Importantly, European financials have begun to outperform the market (Figure 1). With European financial stocks rising faster than the market since early April, the odds of macro shocks or worsening economic conditions are falling.

Image courtesy of Stockcharts.com

Figure 1: European financials have begun to outperform

The problems in Europe are also being eased by a sharp decline in peripheral European bond yields3, and well received bond auctions in Spain and Italy4. Lower yields act as a tailwind for business activity in the months ahead, which is why European equities are holding up much better than the economic data would suggest.

Even in the US where there is the worry that the economic cycle may be turning down, seems to be at odds with how well the S&P500 is holding up. While some may point to the reduced fiscal spending's impact on consumers, as seen from missing expectations of retail sales numbers, the market is more optimistic. Retailers continue to trend higher (Figure 2) in the face of the payroll tax increases. This suggests that the reduction in take home pay due to increased taxes is more than offset by rising wages and more people finding jobs.

Image courtesy of Stockcharts.com

Figure 2: Stocks of retailers making a new high

Nonetheless, we need to see continued outperformance by the cyclical sectors to be more positive in the longer term. The current strength in the defensive sectors reminds us that we are in a maturing bull market and hence must be mindful of the downside risk.

Portfolio Positions

No change to portfolio positions for now. However we are watchful of the current situation and will recommend adjustments if we continue to see more negative economic numbers in the coming weeks.

1. April PMI index points to German economy losing steam. 23 April 2013 Deutsche Welle
2. German business gloom grows as export markets wobble. 24 April 2013 Reuters
3. Spanish bond yields drop to lowest since 2010. 23 April 2013 Marketwatch
4. Italian Yields Drop at Bond Auction as Stimulus Boosts Demand. 11 April 2013 Bloomberg

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