25 March 2014

Macro Strategy Update

Market Update - Patience is a Virtue

Executive Summary: Equity markets have been in a period of consolidation since end February, buffeted by economic data coming in below forecast, and concerns about geopolitical risk. Certain sectors have outperformed whilst others are struggling. Now is the time to be selective with what you buy. We don’t see any deterioration of data or persistency of certain negative signals as a precursor to any recession and consequently a bear market. We conclude that a short term correction is more likely on the cards, and we wait patiently to allocate once valuations are at an attractive level.

Portfolio Positions: Our view remains unchanged. We continue to advocate patience whilst awaiting an opportunity to increase allocations to developed markets as current valuations are not appealing just yet.

Sideways Movement

Equity markets have been trending sideways since the end of February, judging by the S&P500 performance (Fig 1). However, looking at the past year’s outperformers, a different story emerges. The Biotech (Fig 2) and Internet (Fig 3) sectors, which were up 75% and 59% respectively, are now teetering on the brink of correction. The rally in biotech had pushed valuations to extremely optimistic levels and technology names which performed strongly in 2013 have also been sold off. This shows that investors getting more selective when buying stocks and are demanding that companies have to live up to earnings expectations.

Image courtesy of Stockcharts.com

Fig 1: S&P 500 has stalled since late Feb

Image courtesy of Stockcharts.com

Fig 2: Biotech Sector Dropping 10% From Its Record in Feb 2014

Image courtesy of Stockcharts.com

Fig 3: Internet Stocks Have Dropped Below Their 50-Day Moving Average

Weakening Breadth

Market breadth has been slowly declining as shown in the chart below. The number of stocks in an uptrend, defined as trading above its own 200-day moving average, continues to fall (Fig 4). This calls the sustainability of the current rally into question.

Image courtesy of Stockcharts.com

Fig 4: Market Breadth Has Failed to Reach Mid-2013 Levels

Bear Market or Correction

The weaker market breadth and the correction in the higher beta sectors of the S&P500 could alert us to the possibility of a bear market or even a recession. However, we do not see strong evidence of such a case. The Fed has also shown its optimism in the growth of the US economy, with tapering proceeding as planned and indications of a possible interest rate hike sooner than later. The Fed’s confidence is not misplaced as there are indications that the economy is improving. US leading indicators continue to trend positively (Fig 5), cyclical stocks are still in an uptrend (Fig 6), while defensive stocks continue to struggle (Fig 7).


Fig 5: Leading Indicators Are Positive

Image courtesy of Stockcharts.com

Fig 6: Cyclicals Uptrend Intact

Image courtesy of Stockcharts.com

Fig 7: Defensives Have Struggled

Conclusion

We remain bullish in the longer term. However, in light of a few persistent negative signals, we see credible odds of a correction in the market in the near term. As such, we advocate the need to be patient and selective in our asset allocation. We would only enter the market when valuations are compelling.



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