Note February 21,2018: Markets Matters of Choices: Worldwide capital market correlations had previously appeared to loosen but do seem tighter in the aftermath of equity market drops in early February 2018, amid continued increases in U.S. Treasury fixed income instrument yields. When the U.S. and China closed markets on holidays this week, many others were unable to holdup. When the present market cycle commenced in 2009 in the midst of credit debacle, much depended on central banks. Now, U.S. 10 year Treasury Note yields at 2.95% are already over double their lows and could reach 4.75% by Q1/2019 as the grip of quantitative ease loosens on markets. As the potential for valuation gains become flaccid, choices matter in the markets. Alongside higher volatility, vestiges of momentum remain. They appear in junk bonds and favor for the Yen on more quantitative maneuvering. Instead, we favor short duration. Further in global allocation, we favor commodities diversification via markets like Australia and Canada. In equity growth and unlike tradition for this stage, we favor Information Technology over Healthcare and Consumer Staples on valuation and delivery. In cyclicals, we see Consumer Discretionary as mired in wrenching late cycle restructuring and favor Industrials instead. In tangible assets, we favor adversity restructured Materials and Energy over Real Estate that has gorged on low rates and easy money. On restructuring and balance sheet strength amid potential rate increases, we favor Telecommunications Services over Utilities, reputedly an income safe haven. Financial Services remain crucial for most equity markets but realities worldwide show the advantages still to lie with those earliest and most ruthlessly into restructuring.
Traditionally within equity growth when reaching for defensiveness and balance sheets, Healthcare and Consumer Staples have been favored for late stage markets. This business and market cycle have been different. Present day results demonstrate that after major merger and acquisition activity as well as after experiencing sustained product maturity, Healthcare needs to restructure once more. In Consumer Staples, global delivery has been weak when derived from expanding their current portfolios of products as domestic competition appears to have been better attuned to local conditions. Brand pruning and cost cutting appear as imperatives for global companies. Meanwhile on yield demand in capital markets amid lowered administered rates, valuation was boosted strongly for both sectors. Meanwhile, stronger balance sheets and more individual as well as sector ruthlessness has made Information Technology more interesting within growth. In cyclicals, the large economic size of consumer discretionary activity often comes in for favor, especially early in the cycle. However, the world economic cycle bottomed several years ago and is currently advanced. In addition in this cycle in many advanced as well as emerging economies, the consumer appears overleveraged due to low interest rates. Within consumer discretionary, demand change exists from millenniums for instance and competition from online technology appears broadening. By contrast and even taking into account technology change, cyclical demand for public infrastructure and private capital investment appears overdue and favors industrials at this stage for cyclical exposure.
Muted earlier in this cycle, inflation has been rising which is not unusual at an advanced stage of any business cycle. A notable feature of this cycle from major financial centers to small emerging country locations has been the extent to which real estate assets have already been boosted by many years of easy money and artificially contained administered and fixed income rates. They may now offer limited hedges. Price resistance in real estate can already be seen in the financial centers as can overbuilding in emerging economies. Due to affordability constraints among millenniums and other cohorts, there also appears a move back to parents phenomenon. Meanwhile, Materials and Energy seem more attractive tangible assets in that both have experienced wrenching restructuring in their businesses. Interest therefrom could rise as potential exists for dislocations in capital markets due to inflation, political and trade tensions. Among the rate sensitives and as a result of dividend yields being income proxies amid low fixed income yields, Utilities have been early beneficiaries in the cycle. Now and even absent runaway inflation such as afflicted the 1970s, interest rate increases could add to capital budgeting pressures even as capital equipment and facility investments loom. Instead of Utilities among traditional rate sensitives, we favor Telecommunications Services on its restructuring into a handful of companies in major markets and on balance sheet strength. Financial Services remain a critical factor in most equity markets. Stemming from misplaced risk assessment on credit, its restructuring has stretched into international regulatory change like Bale III and domestic regulatory change. It continues even now a decade after the flaring of credit crisis and, low interest rates notwithstanding, includes capital replenishment. The last comparable period for the Financials would arguably be the emerging debt crises of the 1980s/1990s followed by the Brady plan of sovereign debt restructuring that was also prolonged. Recent worldwide realities still show the Financials to be crucial to market direction with the advantages likely to lie with those earliest and most ruthlessly into restructuring.
As the potential for valuation gains becomes flaccid, choices like those above matter in the markets. As the grip of quantitative ease loosens on markets, we expect that capital market volatility will be significantly above that of 2017. In reaching close to 2.95%, U.S. 10 year Treasury Note yields have more than doubled from their lows and could reach 4.75% by Q1/2019. In fixed income markets, it is noteworthy that CCC rated junk bond yields appear to have been among the last to move higher. As well, vestiges of momentum seem favoring the Yen on more quantitative maneuvering. Even by current standards, the minuscule yields of Japan and its high debt to GDP ratio appear to offer little support in case of unforeseen adversity. On the contrary, liquidation of offshore assets by large holders like Japan and China would raise volatility risk. In addition to deficit pressures in public budgeting, global political and trade tensions appear rising. We favor short duration. Also, in global allocation, we would advocate commodities diversification via markets like Australia and Canada.
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.
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