Tuesday, February 18th, 2014

Secular Growth

In the middle of January our US sector model passed a significant milestone; Consumer Discretionary fell out of the top three sectors for the first time in 118 weeks, ending the longest run at the top of the ranking in the history of our model (which goes back to 1995). Cue deafening silence and a couple of polite yawns! Why do we care? To put this in context, the next longest run at the top of the ranking was 93 weeks for the Technology sector which ended in July 2000. At the bottom of the ranking, the longest run was 122 weeks from Financials, which ended in July 2009. As far as our model is concerned, the shift out of Consumer Discretionary is as important as the end of the Tech bubble, and the end of the Financial Crisis – truly, the end of an era.

Investors have been betting on the US economic recovery for so long (since October 2011) that it feels like they have never done anything else and that the run could go on for ever. It can’t and it hasn’t. It’s time for a change. This doesn’t mean that Consumer Discretionary is suddenly a raging sell, only that it is well-owned and that there a very few marginal buyers.

The two sectors now at the top of our US ranking are Healthcare and Technology, neither of which is a direct play on the US recovery. It could be possible to interpret the shift into Healthcare as a move towards a more defensive strategy, were it not for the fact that the other defensive sectors, Utilities, Consumer Staples and Telecom, are ranked #7, #8 and #10 respectively. Similarly, the move into Tech looks to be more sustained than the seasonal pattern of fourth quarter strength which we sometimes see from this sector. We believe the theme which unites these two sectors is secular growth. This explanation also fits well with a shift at the macro level away from an extreme overweight position in equities and towards a more neutral position. (Buy the right equity – not any equity.)

This idea may also garner some support from an unlikely sector, namely Materials, which has recently moved into the #5 position (contrasting with its #8 position in Europe). The secular growth story here concerns chemical companies such as Dow and Du Pont using low-cost shale gas to gain market share in international export markets. None of this new; it’s just more important than it was last year.

We see similar forces at work in Europe, but with a time lag. At the end of October, Consumer Discretionary and Industrials were #1 and #3 respectively in the UK. Now they are #2 and #4 and their probability curves suggest that they will slip further down the ranking in coming weeks. Over the same period, UK Health has gone from #6 to #3 and the probability curve also suggests this has further to rise. Finding other sectors which benefit from a secular growth theme is much harder in the UK – not least because the Tech sector is so small – but we should not quibble if the UK decides to follow the US where it can. It is also worth noticing that Tech has gone to #1 in Japan.

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