The US mar­ket’s sil­ver lining

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

We are no bulls on the US mar­ket. Even if growth re­mains solid, our view is that US eq­ui­ties will strug­gle to post yet an­other year of out­per­for­mance given that val­u­a­tions are al­ready stretched, the Fed­eral Re­serve is no longer the eas­i­est cen­tral bank in town, and the US dollar is no longer su­per­com­pet­i­tive.

Even worse, de­cent growth is not a given. While we re­main rel­a­tively up­beat about the US growth out­look over the next 12-24 months, we have to ad­mit that much of the re­cent data has been unin­spir­ing. While Europe and Asia have sur­prised on the up­side this year, US data has mostly come up short. So what is an in­vestor to do?

One op­tion would be sim­ply to un­der­weight or avoid the US eq­uity mar­ket. In­deed, we con­tinue to rec­om­mend shift­ing eq­uity port­fo­lios away from the US and to­ward Asia, where val­u­a­tions are more at­trac­tive, mon­e­tary pol­icy is eas­ing, cur­ren­cies are ei­ther sta­ble or com­pet­i­tive, the fall in oil prices is pay­ing hand­some div­i­dends, and eco­nomic in­te­gra­tion led by China has the po­ten­tial to pro­vide a struc­tural tail­wind.

But for in­vestors who need or want to main­tain some US eq­uity ex­po­sure, where can cap­i­tal best be put at risk? Recog­nis­ing that there is sig­nif­i­cant over­lap, we rec­om­mend the fol­low­ing:

1) Over­weight do­mes­tics, multi­na­tion­als and ex­porters.

while

avoid­ing

US

Ob­vi­ously the driver here is the stronger US dollar, but a health­ier US con­sumer also plays into this trade.

2) Over­weight ser­vice providers, un­der­weight com­pa­nies pro­duc­ing and/or hold­ing in­ven­to­ries of goods.

This is not just a re­state­ment of our first call. Sure, a lot of ser­vice providers are do­mes­tics, while a lot of goods’ pro­duc­ers and traders are multi­na­tion­als or ex­porters (or com­pete with for­eign­ers). But this call is also geared to re­cent price falls in com­modi­ties and man­u­fac­tured goods. In­ven­tory-to-sales ra­tios have shown a wor­ry­ing rise in the man­u­fac­tur­ing and whole­sale sec­tors, as out­put prices have fallen faster than the book value of in­ven­to­ries (pro­duced with ma­te­ri­als bought nine months ago). This helps to ex­plain why a lot of the re­cent US data misses have come from the man­u­fac­tur­ing sec­tor.

3) Over­weight con­struc­tion.

US

hous­ing

and

res­i­den­tial

Much hous­ing data has been good re­cently: new home sales have picked up in the last three re­leases af­ter two years of stag­na­tion. Pending new home sales have also ticked up. And house prices are show­ing early signs of a reac­cel­er­a­tion, af­ter ap­pre­ci­a­tion slowed to 5% in 2014. This makes sense to us. The im­proved labour mar­ket sit­u­a­tion bodes well for house­hold for­ma­tion and hous­ing de­mand. With the ex­cep­tion of yes­ter­day’s ADP es­ti­mate, labour mar­ket data has been strong this year. And although ag­gre­gate wage growth has been lack­lus­tre in nom­i­nal terms, it has been strong in real terms. Plus more and more busi­nesses are an­nounc­ing wage hikes (McDon­ald’s be­came the lat­est ex­am­ple last week). Given the lull in con­struc­tion fol­low­ing the hous­ing bust, our es­ti­mates sug­gest that this re­bound in de­mand in an en­vi­ron­ment of low mort­gage rates will drive a pick-up in con­struc­tion. Of course there is over­lap here with our first two calls. US home­builders are do­mes­ti­cally fo­cused, with al­most no ex­change rate ex­po­sure. For all th­ese rea­sons, home­builders may be the bright­est sil­ver lining in a largely unattrac­tive mar­ket. Per­haps this is why the S&P 1500 home­builder in­dex has out­per­formed year to date, break­ing out of its two-year trad­ing range last week to set new cy­cle highs.

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