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Turning point for markets: sectors to explore or ditch
Society is at a turning point and so is the stock market as the focus shifts from Covid recovery opportunities to the threat of rising inflation and changes to monetary policy. Fundamentally, what’s worked this year in terms of stock selection may not continue to do so.
Companies will need to show they can pass on higher costs to customers or have substantial gross margins to be able to stomach inflationary pressures. Others will have to deliver on earnings expectations as even the slightest miss could be punished by a big share price decline, given how parts of the market are trading on elevated valuations.
At the start of 2021, earnings forecasts were quite bullish, based on the premise that companies would come out of the pandemic in decent shape and a strong economic recovery would drive corporate earnings.
First quarter results were good for a wide range of industries. Reality is now sinking in and we could see a divide in terms of positive and negative reporting at the second quarter results, which should get underway in late July.
The global stock market, as measured by the MSCI All Countries World index, was up by nearly 13% in the first half of 2021, according to FE Fundinfo, and has just hit another all-time high. The FTSE 100 index of UK stocks is up 8% year to date. These are good performance figures.
There are new factors for investors to digest, such as the US Federal Reserve signaling it will raise interest rates sooner than expected. US President Joe Biden in late June declared ‘a deal’ on a $1.2 trillion infrastructure spending plan, which has fired up markets again. However, the infrastructure boom is not ‘new’ news, so may not be a long-lasting share price catalyst.
In terms of UK stocks, Morgan Stanley says pharmaceuticals has been the best performing sector, outperforming the market by 9% in the past three months. This is despite deteriorating earnings per share trends. It says valuations are now back towards their long-run averages.
Travel and Leisure has been the worst performing sector in the past quarter, underperforming by 10%. It has the weakest relative earnings per share revisions in the UK and valuations look increasingly stretched, meaning anyone who has been playing this sector as a reopening trade may want to lock in any profits.
Oil and gas has been the second worst performing sector relative to UK market, lagging by 7% during the past three months despite strength in the oil price. The sector continues to see positive revisions to earnings per share and dividend estimates, suggesting this could be a good place for investors to explore despite ongoing concerns about the industry having to transition to a renewable energy-led world.
Consumer staples is the most oversold UK sector, according to Morgan Stanley. Performance trends have started to turn in recent weeks and the sector is seeing an improvement in relative earnings revisions. The bank says that relative valuations are close to a historical low and the sector may offer some good value defensive exposure.
Other sectors to watch closely include retail, where share prices appear to be losing momentum, while on a global basis technology stocks seem to be regaining favour with investors again.