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Why a sectoral shift raises big questions
The agricultural revolution introduced by 18th century British statesman Charles ‘Turnip’ Townshend may, at first glance, have no bearing at all on how investors could think about their portfolios and any tactical or strategic asset allocation decisions.
Townshend argued that crop rotation was a vital tool in the farmers’ toolkit when it came to maximising yields from the fields. By the same token, investors need to be aware of the power of sector rotation within stock markets.
Even if the market will never always be right, its views must always be respected and shifts in performance momentum between the 39 industrial groupings will reflect wider thinking on the overall backdrop. Sometimes, one sector’s fall from grace and another’s return to favour can be no more than a knee-jerk reaction to a specific event. But when sectors that share similar characteristics start to do well (or badly) as a pack then attention should be paid, especially if their momentum (positive or negative) represents a major change from prior trends.
The tables show the best and worst performing sectors within the FTSE All-Share index, on a quarterly basis, in 2019 to date.
To this column’s eye, there is a clear difference between the type of sectors that did well (and badly) in the first two quarters of the year and those which have risen to the top of the pecking order (or sunk to the bottom) since summer came to an end. In general cyclical sectors that are sensitive to the global economy took charge in Q1 and to a lesser degree in Q2. This includes Industrial Metals & Mining, Mining and Industrial Engineering. Such sectors have since fallen from favour, with Autos & Parts and Industrial Metals & Mining down among the dead men in both Q3 and Q4.
As a mirror image of the first trend, defensive sectors have started to work their way back to investors’ affections. Healthcare and Pharmaceuticals both had a good Q3 and Electricity and Gas, Water and Multi-Utilities are ending 2019 with a flourish.
This may reflect concerns over the UK economy, given its apparent pre-Brexit state of paralysis, and the slow rate of progress in the US-China talks that are trying to resolve the trade dispute which seems to be weighing on global trade volumes. The utilities’ renaissance may surprise some given the promise of nationalisation offered by the opposition Labour Party, so it remains to be seen whether investors are underestimating the chance of Jeremy Corbyn and John McDonnell entering 10 and 11 Downing Street respectively.
A number of serial underperformers from the first half are doing much better in the second. This again includes the utilities but also brings in Fixed Line Telecommunications, Life Insurers and sectors such as General Retailers, Real Estate Investment Trusts, Real Estate Investment & Services and Construction & Materials. Some of these groupings rely heavily on the UK economy for their bread and butter, so this could represent a move toward ‘value’ stocks. If that is too bold a call, it could at least mean investors are reappraising those domestically-focused sectors that have been out in the cold since the EU referendum vote of summer 2016. Even if we are still lacking clarity on Brexit, hopes for some kind of deal may be tempting some to take another look to downtrodden names and this can be seen in how ‘value’ stocks are rallying while ‘growth’ stocks are losing some momentum for the first time in a while.
Such a move from strategies based on ‘growth’, ‘momentum’ or ‘quality’ toward ‘value’ would be a huge change and have huge implications for asset allocation and fund and stock selection if it persists. Value-disciples suffered false dawns in 2016 and late 2018 so they will not be getting carried away yet, although there are tentative signs that this is not just a UK phenomenon.
The sectors which make up the S&P Global 1200 show some similar trends, with cyclical/value plays like Banks doing better while ‘expensive defensives’ such as Consumer Staples are lagging. But Technology is still holding up well and Real Estate is making heavy weather of the fourth period of the year, so it is by no means a clean sweep for those who are awaiting a decisive shift from ‘growth’ to ‘value.’ Watch this space.