THE QUANTITATIVE STRATEGIST – JUNE 2013
Global economic backdrop – China spoiling the anticipated recovery? China is slowing down and it feels like this time around, a more profound downturn lies ahead. The government is clamping down on shadow financing activities, but in the meantime, real lending rates seem too high and the rapid appreciation of the yuan is such that tight monetary conditions signal a marked slowing in Chinese exports this summer. China accounts for ~35% of world GDP growth, and we assign more than a 50% probability for China’s GDP to fall below the government target of 7.5% this quarter or next. Should policymakers fail to respond through monetary or fiscal stimuli, a global economic recovery expected to begin in H2/13 could be pushed back. However, with monetary reflation broadening out in other areas of the world, the risk to the global economy, we believe, is a growth delay rather than a relapse.
Asset mix strategy –
Who is more scared? Equity or bond investors? It has now been 147 days without a 5% pullback on the S&P 500. But despite the risk of a correction rising, investors should keep a pro-cyclical positioning. The bond market remains a poor alternative to stocks, and once market froth is removed, equities should resume their advance with bond outflows feeding stock inflows. With the duration of US and Canadian 10-year government bonds at nine years, the 50bp increase in bond yields in May led to an ~4% drop in bond prices. A move to the 200-week moving average at 2.6% would create another 4% loss to bond investors. So we ask again! Who should be more fearful about downside risk? Stock or bond investors?
Equity sector strategy – Rising bond yields trigger a change of guard. As investors were reminded in May, economic growth is not the sole differentiating factor between defensive and cyclical stocks. Valuation, earnings, and the trend in bond yields also matter, and these attributes suggest a continued shift out of defensives into cyclicals. For now, stay overweight non-resource cyclicals vs. defensives. We are neutral on resource cyclicals, but recommend accumulating shares on price dips. An overweight stance awaits liquidation in commodity pits, policy easing in China, and a US$ peak.
Energy (MW): Downside risk to crude, but rising bond yields means go upstream.
Forest products (MW): Lumber mills are cranking up capacity again.
Machinery (MW): A long way to go before global mining austerity runs its course.
Cdn. Food and Drug Retailers (UW): The low volatility trade is increasingly at risk.
Health Care (OW): The best defense. Stay long pharmas and short utilities.
Financials (OW): Short interest at all-time highs on Canadian banks.
Technology (OW): Like Cisco’s John Chambers, we see growth in the US and EMs. Telcos/Utilities (UW): The most sensitive sectors to rising bond yields.
- JPMORGAN’S TOM LEE: We Are On The Cusp Of A ‘Regime Shift’ In The Stock Market (businessinsider.com)
- How to Protect Your Portfolio From Rising Interest Rates (minyanville.com)
- Investment Expert Landesman: Fed Tactics Have ‘Insanely’ Inflated Stocks (moneynews.com)
- Is This This Really The End For The Great Emerging Markets Bull Run? (businessinsider.com)