- Financial Times – Time for investors to prepare for the next cycle
Diversification and flexibility are key ahead of potentially long period of volatilityAlas, late-cycle booms typically mark the beginning of the end. As spare capacity erodes and central banks focus on removing accommodation, the risk of accidents in the real economy or in financial markets is rising. Thus, it is time for investors to prepare for a potentially long period of more volatile and plateauing asset prices, because it often precedes bear markets for risky assets. To be sure, there is nothing in the economic data or financial indicators to suggest that a global recession is imminent. Unlike in the past few cycles, consumers have been relatively thrifty, house prices do not look excessive and the corporate sector has not over-invested in fixed capital — if anything, the opposite has occurred. Also, financial conditions remain favourable despite recently higher equity market volatility, and fiscal policy is expansionary, especially in the US. Against this backdrop, barring a big geopolitical event or a full-blown trade war, the global economic expansion appears to have room to run for another year, or maybe two. However, the risk of a recession soon thereafter is high and rising.
- Morningstar – Industrials Up On Cyclical Bias — Industrials Roundup
Shares of manufacturing and transportation companies rose as traders rotated back into cyclical sectors that were dinged last week by fears of conflict in the Middle East. One money manager warned that some ingredients for the volatility will remain in place even if Middle East tensions abate. Economic data appears to have hit a soft patch,” said Bob Doll, chief equity strategist at money manager Nuveen Investments. “Recent U.S. employment readings were worse than expected, while global manufacturing levels trailed off.”
Summary
Sharp decelerations in hard (official release) economic data in the U.S. and Eurozone threaten to undermine a shift into cyclical sectors that began last October. High oil prices and trade-tension-fueled rallies in industrial metals have complicated the outlook for energy and basic materials sectors. These sectors are likely to underperform if Eurozone official release data continues to deteriorate and brings down U.S. hard data with it.
Comment
The chart below shows Citigroup’s hard (official release) economic data change indices for the U.S. and Eurozone. These measure economic growth in official releases relative to one-year averages. We’ve highlighted how economic surveys have become false prophets but hard (official release) data still offers a clearer view of underlying economic performance. U.S. hard data appears to have stabilized but Eurozone economic growth continues to fall toward zero, its one-year average.
The acceleration in U.S. hard data last October sparked a pronounced rotation into cyclical sectors among U.S. equities. The next chart shows cumulative net flows for U.S. sector ETFs since the beginning of the last risk-on move, May 15, 2017. The stabilization and subsequent acceleration in realized growth spurred net inflows into energy, industrial and materials sector ETFs. These inflows have persisted despite February’s setbacks and sharply higher volatility.
While investors appear to have maintained their exposure, performance among these cyclical sector ETFs has been middling since February. All three sectors missed out on the bounce in technology and financial stocks immediately after February’s debacle. But strength in industrial metals and energy prices is driving recent outperformance in energy and materials.
The last set of charts shows some of the top performing industry groups in the S&P 500 since the October rebound in U.S. hard data. That charts show cumulative weekly returns since October 24. It also highlights the increasingly complicated landscape many of these industries face with tariffs influencing raw materials prices.
Aerospace & defense and railroads, two of the largest consumers of steel, are among the top performing industries in the industrial sector. Both are heavily exposed to steel and aluminum tariffs but also likely to benefit from higher geopolitical tensions and the occasional volley of missiles. Industry groups in the energy sector with the closest ties to spot prices are outperforming their peers. And copper miners are outperforming steel producers in the S&P 500 since late October, despite U.S. tariffs on imported steel.
Conclusion
We argued on March 27 that rising trade tensions were a sideshow for slowing growth, despite short-term fluctuations in commodity prices. Tariffs will continue to complicate the earnings landscape for individual companies and industries but realized economic performance will be the true driver of performance. Even with geopolitical risk premiums in play, higher oil prices will need support from global demand. Cyclical sectors will need to see realized economic growth stabilize in the Eurozone and hold the line in the U.S. to perform.