Tuesday, March 25th, 2014

Ringing the Bell

Regular readers will be aware that we are suspicious of anything resembling global sector strategy. (Different Strokes, 25th February 2014). So they are permitted a small smile when we say that we are concerned for Telecom sector in Japan, the UK and the Eurozone. In all three regions the probability curve for the sector is deteriorating. If we were rating it purely on the basis of our short-dated samples, we would have already cut the recommendation from Overweight to Neutral and we would be expecting further downgrades in the near future. In all three regions we have seen a rally driven by M&A activity, real and imagined, and now we see the impetus starting to fade. In our view this is more of a coincidence than a coordinated investment theme, but it is still worth mentioning, partly because it makes a good headline.

We stick with our regional approach to sector strategy because Telecoms is one of the few sectors where we can see common behaviour across a number of regions, (even though it has been bottom of the ranking in the US for 36 weeks). Our current recommendations suggest that the differences between the regions are much greater than the similarities. In the US, our secular growth theme dominates the top of the ranking, with Healthcare at #1, Technology #2 and Materials #3. Some investors may be puzzled by the inclusion of materials as a growth sector, but the shale gas revolution gives the US chemicals sector an opportunity to dramatically improve its competitiveness in global export markets. A month ago wrote that the secular growth theme “fits well with the asset allocation view. If investors are gradually moving from an overweight position in equities towards a more neutral stance, it makes sense for them focus their equity exposure on long-term earnings (and revenue) growth.”

Meanwhile in Europe, we see a confused picture with the UK and Eurozone presenting very different rankings. Where the UK and Eurozone agree, we see a sector at the top or bottom of the Pan-European table. Thus Utilities is now #1 on a Pan-European basis, with a number #1 position in the Eurozone. Despite the #6 position in the UK, there has been a dramatic improvement in the shape of the probability curve in both regions. At the bottom of the Pan-European ranking we see Consumer Staples and Materials, which are in the bottom three in both regions. (Note the contrast with US Materials).

In the middle of the Pan-European table, lies a region of confusion and doubt. Healthcare is #1 in the UK, but #9 in the Eurozone. Financials is #2 in the Eurozone but #8 in the UK. Industrials is #7 in the UK and #3 in the Eurozone. The resulting Pan-European ranking is of course valid in a Pan-European context, but is a poor basis for stock selection unless investors understand the regional background as well.

When confronted by lots of confusing detail, the human brain has an overwhelming urge to simplify. The distinction between coincidence and theme becomes irrelevant; a simple message is all that is required. This week the headline says that Telecoms are in trouble – that the momentum of returns in Japan, the UK and the Eurozone is deteriorating fast and that the level of risk is increasing. Investors should be prepared to take money out of the sector, but where they re-invest it depends on the region and not the world.

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