13 June 2014

Macro Strategy Update

Força (Strength)

Executive Summary: We were cautious since the beginning of the year as data warranted taking a defensive stance for our portfolios. Consumer discretionary sectors, market strength, and even the banking and housing sector appeared weak. However in recent weeks, growth has overtaken value and the economically sensitive sectors of the market have started performing again. Europe’s recovery looks positive, and job creation in the US supports the growth story. With interest rates set to stay low a little while longer, and with central banks around the world still in an easing bias, these are signs that risk aversion is behind us and that strength has come back into the market.

Portfolio Positions: This week, we have sent out rebalancing requests to take off our slight equity underweight position and neutralize all portfolios. Within our equity allocation, we will have an overweight in the US and European markets. Our fixed income exposure will be slightly diversified out of investment grade corporates to prepare for the eventuality of rising interest rates.


Força (Portuguese for “Strength” or “Keep Going”) was the 2004 European Football Championship anthem sung by Nelly Furtado. In the spirit of this football season, we liken the difficulty for predicting how markets would move in the first half of 2014 to picking this year’s World Cup winner. Whilst Brazil is the favorite, investment banks from Goldman Sachs to Deutsche Bank have run quantitative models and come up with a range of winners from England to Argentina. In the same regard, what our data and models showed us was that it was an ever changing investment environment, something that we needed to be nimble about. We started the year being cautious as data warranted a defensive stance for our portfolios. In recent weeks, there are indications that the environment for risk taking is turning more positive and that the market strength has returned.

Caution Behind
Since Jan 2014, several indicators suggested to us that risk aversion was rising. Selectivity was increasing and investors were selling out of momentum and growth, and allocating to “safer” sectors. The consumer discretionary sector underperformed the broader market (Fig 1) and there was a deterioration of market internals (Fig 2). In addition, the banking (Fig 3) and housing sectors (Fig 4) also struggled on a relative basis, which potentially signaled some headwinds for the economy.

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Fig 1: Consumer Discretionary Underperforming

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Fig 2: Falling Number Of Stocks with Bullish Trend

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Fig 3: Banks Struggling on a Relative Basis

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Fig 4: Housing Struggling on Relative Basis

Clearer Skies Ahead
The very signs that caused us to turn cautious are beginning to change for the better. If this is sustained, investors could be well rewarded to take on risk for the second half of 2014. Stocks most sensitive to the economy continue their upward trend (Fig 5). The number of stocks making new 52-week highs have reversed their downward course and have broken higher (Fig 6).

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Fig 5: Cyclical Index in a Solid Uptrend

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Fig 6: New Highs Indicator Has Broken Upwards

Growth Back in Vogue
Following the sell-off in the Mar/Apr period, growth stocks have regained favour with investors and are now back to making new highs (Fig 7), contributing to the improvement in market internals. There has also been a rotation back into cyclical stocks. The consumer discretionary sector has started to outperform staple stocks on a relative basis since May (Fig 8) and defensive sectors like utilities and consumer staples have failed to sustain their recent outperformance (Fig 9). In the fixed income space, high yielding bonds remain the preferred investment choice. Whilst yields on the US 10Y treasury have fallen 55 basis since the beginning of the year, junk bonds returned 4.5%. EM bonds have done even better with a 9% gain. These data points suggests that risk-off behavior is ending.

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Fig 7: Growth Stocks Back in an Uptrend

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Fig 8: Consumer Discretionary Outperforming

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Fig 9: Utilities and Staples Underperforming on a Relative Basis

Europe Recovery
European financials are finally making a new cycle high. Whilst financials have struggled since the start of 2014, part of it could be attributed to the Ukraine crisis and the 2013 rally which tempered investors’ confidence in the region. The recent breakout is a bullish sign and is positive for the equity market (Fig 10). In addition, PMI numbers, industrial production and economic sentiment continue in an uptrend (Fig 11).

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Fig 10: Euro Financials Breaking Out

Fig 11: Eurozone Economic Sentiment Uptrend

Strength In Labour Market
Whilst other central banks around the world carry on with their easing bias, many investors will be focused on the Fed when QE comes to a close in October. A lot hinges on how strong the economy, especially the labour market will be then. So far, it appears to be in decent shape. The US has added at least 200k jobs over the past four months (Fig 12). Manufacturing workers have been working longer hours (Fig 13) and overtime is on the rise (Fig 14). Temp help services jobs, a reliable leading indicator of the job market also continues to rise (Fig 15). Whilst QE may end soon, there are strong hints that the Fed would continue to keep interest rates lower for longer, to support the labour market and the economy in general, so long as inflation is not higher than 2%.

Fig 12: Non-Farm Payrolls Change

Fig 13: Average Working Hours Have Increased

Fig 14: More Orders Resulting in Higher Overtime

Fig 15: Temporary Help Services Needed


Low interest rates and the economy continuing on its growth path without inflationary pressure creates a conducive environment for risk taking. With market signals turning positive and investors accepting that growth, albeit slower than expected, is returning to the world, financial markets should be supported and reward investors for the second half of 2014.

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