Monday, March 2nd, 2015

Sector Oscars

This week we focus on plain-vanilla sector strategy. The timing is dictated by the Research for Investors/EuroIRP conference in London, where Harlyn is presenting on this topic. Our thoughts are arranged by sector – all rankings are relative to the local index, with Small Caps counting as the eleventh sector.

Energy has been an underweight in every region since early October, when Brent was still at $90/bbl. It is now ranked #11 everywhere, and there is no sign that it is going to bounce any time soon. Irrespective of whether Brent goes to $70 or $45, we think that the whole sector has a prolonged period of restructuring ahead of it.

Basic Materials covers a wide range of businesses. Japanese steel and chemical companies benefit hugely from the devaluation of the yen and are ranked #1. UK miners are affected by the general commodity malaise and are ranked #10.

Industrials are middle of the table everywhere. Their best position is #4 in the UK and the worst is #7 in the Eurozone. They rank behind Discretionary in every region.

Consumer Discretionary is the overall winner, ranking between #1 in the Eurozone and #3 in the US. Our models highlight the powerful inverse relationship with Energy, which is not surprising. Note that Discretionary is preferred to Staples in every region, though the difference is marginal in most cases, apart from the UK.

Staples are just outside the top three everywhere apart from the Eurozone, where they are #3. But in every region our models have been marginally reducing their exposure.

Healthcare is in the middle of the table in Europe, and in the top three in the US and Japan. But everywhere our models have been reducing their exposure. We don’t think there is a fundamental problem with the sector, it’s just that it was everyone’s favourite in 2014 “and the times they are a-changing”.

Telecom is #1 in the UK and #2 in the Eurozone and in the bottom three in Japan and the US. This shows how important the current wave of merger mania is and what will happen when it’s over.

Utilities have been hammered in the US #9 and have been left behind by QE in the Eurozone #9. There is little to recommend them, unless oil collapses again.

Financials are in the bottom half of the table everywhere and the models show no sign of increasing exposure. Investors now understand that regulators want the banks to reduce complexity and sell businesses / assets. The question is who is going to buy them?

Technology is back to #1 in the US which is the only region where it really matters. This is mainly due to the stellar performance of Apple since the turn of the year. Without this, the sector would not be in the top three. There is no problem if you think the largest stock in the world can go up by another 20%. We are not so sure.

Small Caps is #8 in the US, but has been improving consistently since early November. It’s an obvious choice for investors worried about the impact of the strong dollar on US large caps. There are early signs of improvement in the UK and Eurozone as well.

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