28 May 2014

Macro Strategy Update

Grinding Up

Executive Summary: Developed economies continue to post better macroeconomic numbers, and emerging economies especially China appears to be stabilising. Investors’ preference for value over growth and the rotation out of higher beta sectors during the past few months showed that market internals were weak and there were signs that caution was necessary. Recently, the trend appears to have changed since early May as growth stocks have started to outperform again. However, as some sectors continue to struggle, it is a signal that we cannot be fully bullish just yet and we should approach the markets with some caution.

Portfolio Positions: Our view remains unchanged. We continue to advocate patience whilst awaiting an opportunity to overweight the developed markets in our portfolios. However, we will be preparing ahead, and seeking opportunities in EMs to add to our portfolios when growth characteristics and valuations become compelling.

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Getting Better
Recent economic data tells us that the global economy continues to muddle along. Preliminary estimates on the manufacturing sector show that the expansion remains intact in the US (56.2) and Europe (52.5). Meanwhile data out of China has given the bulls some hope that the worst is over for the manufacturing sector, with the latest preliminary PMI rising from 48.1 to 49.7. Although still in negative territory, it is the first significant improvement since September 2013. We have highlighted our preference for developed economies for the time being as emerging countries continue to face internal problems although pockets of value are appearing. Advanced economies continue to report better industrial production numbers whilst emerging economies face slower growth rates (Fig 1).

Fig 1: Developed Countries Getting Better Whilst Emerging Countries Slowing Down

Central Bank Policy
There were no new developments on the monetary policy front. The Fed continues to keep tapering on track as the labour market in the US recovers. The Bank of Japan continues to watch from the side-lines, adopting a wait-and-see attitude after a higher sales tax induced slowdown in economic activity. Meanwhile in Europe, the ECB maintains its readiness to act should deflationary pressure rise, building up expectations that some action is due in its June policy meeting.

Internal Correction
The S&P500 closed last week at a new all-time high. Despite the markets’ perceived strength, other key indices like the tech-heavy Nasdaq Composite, the small cap Russell 2000, and certain sectors like consumer discretionary remain in a downtrend. There had also been some investor rotation from growth to value stocks since the beginning of Mar 2014. The disparity in performance explains why market internals remain weak, one of the reasons why we turned cautious at the beginning of 2014 (Fig 2).

Image courtesy of Stockcharts.com

Fig 2: Growth Underperformed Since Early March But Has Recently Caught Up

Growth Outperforming Again
However, what is more interesting is how markets have been responding in the past few weeks. Having under performed in recent months, sectors like growth stocks, small caps and consumer discretionary stocks are beginning to outperform again. This is best illustrated when we look at the relative performance between growth and value stocks (Fig 3). If sustained, it could signal the end of the rotation from expensive to cheap stocks. It could also signal that investors are more confident that the economy can wean off monetary stimulus from the Fed, thus paying a premium for growth.

Image courtesy of Stockcharts.com

Fig 3: Growth Starting To Outperform Value Again

Some Caution Still Necessary
In order for a conducive environment for more bullish investing, future earnings will have to come in better than expected, which would mean that economic growth has to be stronger, even beyond Q2. Here is where we get a little concerned. The fact that financial and housing stocks are struggling gives us a warning that we may see slower growth numbers from the US in 2H 2014. Unless financial stocks and all of the cyclical sectors begin to outperform again, it is difficult to see how the bull market can carry on without a significant breather. As such, we view the market with caution until we have the go-ahead to be fully bullish.



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