11 March 2014

Macro Strategy Update

Long Term Bullish, Short Term Cautious

Executive Summary: Our 2014 outlook highlighted that we continued to see signs to confirm our long term bullishness; but had to batten the hatches against short term market volatility. Economic data from the US and Europe continue to show signs of growth, but warning signs like financial sector weakness and credit spreads are still present. As the Fed winds down its 5-year experiment in loose monetary policy and other central banks spool up their printing presses, it is likely that we will continue to encounter rising volatility. As investors, we should keep an eye on our long term goal, whilst taking advantage of any short term corrective opportunity that may arise.

Portfolio Positions: We continue to maintain a small equity underweight whilst awaiting an opportunity to increase allocations to developed markets as current valuations are not appealing just yet.


Volatility to Stay
The up and down start to 2014 has caused investors to be less optimistic on equities. The latest fund manager’s survey by BofA Merrill Lynch showed a net 45% of respondents were overweight global equities, compared to 55% in January. This decline has yet to impact stock markets as global equities are up half a percent to date.

Employment Strength
Despite the extreme cold weather in the US, the world’s largest economy continues to grow. The Bureau of Labour Statistics reported upward revisions in nonfarm payroll employment for December and January by 9,000 and 16,000 respectively. Under-estimation of the number of jobs created is a sign that the economy is growing. Average hourly earnings have climbed sharply (Fig 1), a sign that the labour market may be tightening. The Job Openings and Labour Turnover survey also indicates an increasing job quit rate, showing rising confidence within the workforce (Fig 2). As the Fed is guided by the labour market, the case for reducing bond purchases remains strong and a faster end to the quantitative easing program should not be a surprise.

Fig 1: Workers Pay Is Rising

Fig 2: Higher Employment Turnover

Cyclical Strength
Financial markets have also confirmed what fundamental data has shown. Cyclical stocks in the US have outperformed the broader market over the past twelve months (Fig 3). Meanwhile, defensive sectors like Utilities and Consumer Staples continue to remain out of favour with investors (Fig 4). With growth on a positive trend, investors have chosen to stay with economic sensitive stocks rather than hide in defensive sectors.

Image courtesy of Stockcharts.com

Fig 3: Cyclicals Outperforming the Broader Market

Image courtesy of Stockcharts.com

Fig 4: Defensive Sectors Underperforming the Broader Market

Housing Recovery
Another reason to be bullish on the US economy is that the housing sector appears to be recovering. After a period of underperformance, housing related stocks look set to outperform the market. Over the past six months, housing-related equities have risen faster than the S&P500 (Fig 5), and housing starts and new home sales (Fig 6) continue to gain momentum.

Image courtesy of Stockcharts.com

Fig 5: Home Builders Rising Faster Than The Market

Fig 6: New Home Sales Continue Its Recovery

Developed Economy Recovery
The good economic performance is not restricted to the US only. Latest PMI reports indicate that the Eurozone (53.2), Japan (55.5) and the UK (56.9) continued to expand in February. Air freight data also confirms the ongoing momentum in global growth as European air freight demand grew 6% in January1, confirming the positive numbers from the PMI reports.

Financials and Credit Spreads
Despite the bullish indicators and positive economic numbers, we are short term cautious on taking on risk. The financial sector has struggled to outperform, while the spread between CCC-rated bonds and BB-rated bonds continues to widen. These signals are warnings that have led us to take a more prudent stance this year.

Weaker Breadth
Of significance, we saw deterioration in market breadth during the last 5% correction in January. Since mid-2013, the number of S&P500 stocks trading above its 200-day moving average has been declining (Fig 7). During the last correction in January, there was a sharp decline in this indicator even though the S&P500 lost only 5.8%. This sharp fall could suggest that the psychology towards the stock market has changed.

Image courtesy of Stockcharts.com

Fig 7: Number Of Stocks In Bullish Trend Has Fallen

New Highs
Another indicator of market participation is the number of S&P500 stocks making a new high. Despite the market hitting records, the number of stocks that are making a new 52-week high has come down (Fig 8) compared to previous rallies. This suggests that the level of participation in the current stock rally is narrow, and its strength and sustainability is questionable.

Image courtesy of Stockcharts.com

Fig 8: Number of stocks making new highs has fallen


We have highlighted since January that 2014 will be a tricky year for investors. Developed markets have continued their uptick whilst emerging and asian markets continue to underperform. With the source in loose monetary policy changing from the US to other regions, it is not surprising market volatility remains high. Investors should remain cognisant of their long term goals, whilst taking advantage of any short term corrective opportunity that may arise.

1. Air freight traffic lift gives airlines bright start to 2014. 4 March 2014. flightglobal.com

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