Note November 1 ,2019: Markets and Sector Rotation – We expect capital market volatility to expand through Fixed Income, Currencies and Commodities as well as Equities. It likely favors eclectic sector rotation and security selection over that geographical. Both the European Central Bank and the Federal Reserve appeared to change tack in the summer of 2019. Then, the FOMC statement of October 30, 2019 seems to emphasize a contained approach with Fed Funds rates of 1.75%, to be followed by a so-defined assessment period. Despite internal issues, others stand pat like the Bank of Japan, the Bank of Canada ahead and notably now, the Bank of England. Several appear stressed in emerging areas. Global politics include trade turmoil, China emphasizing command and control, a more assertive Russia and impeachment now in the U.S. political lexicon with turmoil continued in the Levant. These aspects add to the potential for flaring of volatility. In change during the summer of 2019, there appears a drag on lower quality corporate yields being reduced alongside benchmark sovereign yields like 10 year U.S. Treasury Notes.
In the increasingly fractured but critical Financial Services space, legacy credit issues overhang in Europe and Asia in an environment still favoring the most ruthless about restructuring. The same holds for sharply restructured telecommunications within Communications and post its M&A splurge, Healthcare compared to Utilities. The urgent need for business restructuring worldwide in Consumer Staples compared to the strong business profiles of many U.S. based Information Technology seems a headwind to overweighting Europe, irrespective of its aggregate lower valuation. Emerging markets do have growth appeal but as is classical , dependent on global growth improving beyond its currently widely anticipated 3% annual GDP expansion. All these elements can be discerned in this global corporate reporting season. At odds with risk on/off activity based on monetary policy, the mix of equity sector weighting geographically, individual corporate delivery and rotation thereof could become more instrumental than many expect. We also favor above benchmark cash and precious metals exposure.
We expect capital market volatility to expand ranged through Fixed Income, Currencies and Commodities as well as into Equities. It likely favors sector rotation and security selection over that geographical. Both the European Central Bank at the cusp of change in leadership which is now in place and the Federal Reserve appeared to have changed tack in the summer of 2019 as they affirmed additional forms of quantitative ease enhancement, howsoever defined. It has been at the price of increased internal and external dissent. Further, the FOMC statement of October 30, 2019 seems to emphasize a contained approach within the three Fed Funds rates of 2019 to 1.75%, to be followed by a so-defined assessment period. Others have chosen to stand pat like the Bank of Japan with the longest string of such ease and the Bank of Canada ahead and after October elections in Canada. In the midst of Brexit turmoil with a snap U.K. election due on December 12, 2019, so has the Bank of England and needs watching with another meeting due on November 7. Meanwhile, several in emerging areas appear stressed including and not limited to Argentina in Latin America as well as Turkey in the Levant, erstwhile consensus favorites. Global politics include trade turmoil still, China emphasizing command and control in its Central Committee meeting, impeachment now in the U.S. political lexicon amid election positioning and turmoil continued in the Levant amidst a more assertive Russia over a large geographic area. We see these aspects as being relevant in the potential for the flaring of volatility. Aspects appear beyond the penchant in this market cycle for risk on/risk off momentum based on cohesive central bank policy.
On geographic allocation and from time to time, many have espoused positioning that emphasizes the potential for market leadership to shift from the United States and towards Europe on the basis of lower valuation. Such a market leadership shift may have merit in a steady state situation in which economies improve in synchrony and in which restructuring to address weaknesses are lesser imperatives. Earlier in this cycle, as interest rates were both suppressed and ample liquidity enabled refinancing with lesser regard for credit risk, these aspects were at work in the markets with respect to lower quality companies. In change during the summer of 2019, there appears a drag on lower quality corporate yields being reduced alongside benchmark sovereign yields like 10 year U.S. Treasury Notes.
Industry weightings vary widely across markets which makes geographic allocation one that implicitly involves that for sectors as well. Furthermore, among sectors and with respect to the perennial dissection of growth and value characteristics, issues of business performance have industry and individual security delivery aspects to consider. Much more so than during its catharsis of 1999/2000 for instance, within Information Technology today, companies with strong financials and business delivery profiles but lower valuation and higher yields can be distinguished from the alternates of concept purveyors. The same holds for sharply restructured telecommunications within Communications and post its M&A splurge, Healthcare compared to Utilities. Erstwhile defensives may have been favored due to a stretching for yield but they also have business issues such as in Utilities with respect to addressing climate change and in Consumer Staples with respect to having again to address flaccid product lines. In the increasingly fractured Financial Services space, legacy credit issues in loan portfolios continue despite prolonged quantitative ease. Delays in restructuring in Europe and Asia for instance have been leading to an environment still expanding the space between those most ruthless in restructuring and laggards hoping for external relief.
All these elements can be discerned in the corporate reporting season currently globally underway. It is of import in geographical versus sector allocations in the last quarter of 2019. For instance, European markets have particularly heavy weightings in Consumer Staples and lower weightings than those of the United States. The urgent need for business restructuring worldwide in Consumer Staples compared to the strong business profiles of many U.S. based Information Technology would act as a headwind to overweighting Europe irrespective of its aggregate lower valuation. The same holds true in the critical Financial Services sector due to the more aggressive earlier restructuring in the United States compared to its lag in Europe with balance sheet and portfolio duress still flaring. Emerging markets do have growth appeal but as is classical depend on global growth improving to beyond its currently widely anticipated 3% annual GDP expansion.
At odds with momentum stances derived from risk on/off activity based on monetary policy, an eclectic mix of equity sector weighting geographically, individual corporate delivery and rotation thereof could become more instrumental than many expect within and amongst markets. We also favor above benchmark cash and precious metals exposure. StrategeInvest’s independent consultancy operates as Subodh Kumar & Associates. The views represented are those of the analyst at the date noted. They do not represent investment advice for which the reader should consult their investment and/or tax advisers. Any hyperlinks are for information only and not represented as accurate. E.o.e.