Hello and welcome to this month’s equity market review with me, Ritu Vohora.
In July, global equity markets enjoyed their strongest month so far this year, with cyclical regions and sectors leading performance. Positive news came from strong growth data in China and better-than-expected results from earnings reports in the US. The global index rose in sterling and US dollars, but fell marginally in euros as the currency continued to strengthen.
Emerging markets and Asia-Pacific ex Japan were the best performing regions, while the US lagged.
A significant rebound in oil was the big story in commodities with Brent crude rising 12% and recovering almost all of June’s losses. A decline in US stockpiles was the major driver, alongside a weaker dollar. Gold also had a solid month, recovering from early losses to end July up around 2%.
Looking at sectors, materials led performance followed by technology, as the cyclical rotation continued. Classic defensive sectors, including healthcare and consumer staples, underperformed. From a style perspective, momentum outperformed across all regions, whilst other styles were mixed.
In this month’s theme we ask if cyclicals are back in the driving seat of the equities rally.
Equities have continued to move higher this year, with some indices boasting historic highs. However, the style leadership of the rally continues to change, with bond yields an important driver.
In the second half of twenty-sixteen, as bond yields began to rise on reflation expectations, investors became more risk tolerant and there was a significant rotation away from the defensive ‘bond proxies’ into more cyclical sectors. These sectors outperformed strongly when bond yields rose following the US election last November.
In the first half of this year, bonds rallied as reflation expectations subsided and equity leadership switched back to defensives. That lasted until the end of June, when, as we covered in last month’s video, central banks began a concerted move towards a more normal policy environment. Defensives have now handed the baton back to cyclicals.
Investor sentiment and preference for safety over the years since QE was introduced, has pushed many defensive stocks to trade on expensive multiples. Their valuations now look stretched. On the flipside, cyclicals for the most part remain attractively valued and look to provide the best opportunities. This is especially the case as we move to a more normal macro environment.
A normalising global economy, with growth picking up and interest rates rising slowly, should be good news for risky assets such as equities and specifically for cyclical and value stocks. Importantly, robust economic data across the world supports the global reflation trade and with interest rates rising from such a low base, it could take some years before they reach restrictive levels.
Another key driver is earnings growth. Corporate earnings, largely stagnant over the last seven years, appear to be strengthening over recent quarters with many companies seeing upgrades to their twenty-seventeen earnings estimates. This is particularly the case for cyclical stocks.
Currently, global sectors with above-average earnings and price momentum are all cyclical. These include banks, industrials, tech and materials. In contrast, the more traditionally defensive sectors all have below-average earnings and price momentum, including consumer staples, utilities, and telecoms. History suggests stocks with relatively strong earnings and price momentum tend to outperform.
With the global economy on a relatively stable growth path, earnings improving and a high level of available capital for corporate investment spending, cyclical and value stocks look to offer the most potential.
Improving fundamentals indicate the long-running bull market for equities remains intact and a modestly pro-cyclical stance seems appropriate in the current environment.
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That’s it from me and see you next time.