An improving outlook for the inventory cycle should benefit cyclical sectors, according to FE Alpha Manager Julie Dean (pictured), who says she has been adding to manufacturing and financial stocks on weakness. Dean, who uses a business cycle approach when investing in her five-crown rated Cazenove UK Opportunities fund, anticipates a market correction of some kind in the near future, but says she is likely to add to her exposure to pro-cyclical assets in this event, rather than defensives.
“It’s difficult right now – the odds are very stacked against you because of the prices on offer,” she explained. “In a sell-off, where would you go? Highly rated safety, or value?”
“I’m inclined to say that I’d go in to higher beta value stocks given our understanding of where the inventory cycle is.”
“So far in this business cycle it has been right to buy ‘cheap’ cyclical earnings risk into weakness and we think it will be right to do so again this year as the inventory cycle picks-up and industrial cyclicals will benefit as this growth comes through.”
The inventory cycle refers to the rate at which businesses replace their stockpiles – or inventories. When times are tough, companies tend to hold back on expenditure, but when they get more confident they tend to replace outgoing stock.
“If the inventory cycle picks up, it means that stock is being produced but sitting in warehouses. When the cycle goes down, stock fills the order books, but doesn’t get replaced,” explained Dean.
Though companies have done very well in share price terms, Dean points out that there hasn’t been a sustained inventory recovery. When it eventually does pick up, she says it should provide a big boost for industrial cyclicals such as manufacturers.
“At the moment manufacturers are just producing to order,” she said. “Given how low inventories are, and that there will be continued loose monetary policy, I think they are low enough to rebuild.”
“Once companies start putting down capital for investment, we will see employment come up. However, that tends to be the last indicator, and by then you would have probably missed the upside.”
Dean points to the fact that the UK equity market has risen 11 months in succession as a tell-tale sign that it is due a market correction.
Performance of index over 1yr
Source: FE Analytics
She doesn’t expect there to be a full-scale crash, but doesn’t think economic numbers are strong enough to sustain the rally at the recent pace.
“A correction is certainly overdue, and I wouldn’t be surprised by it,” she said. “The real surprise is that we’ve been climbing the wall of worry for so long. Maybe it does go on.”
“Economic data has been steady but not improving. Europe is still pretty dull and UK manufacturing activity is weak. The US has been doing quite well – there was a good improvement in the early stages in the cycle, but in the last few weeks this has fallen back a bit, as it did in 2012, 2011 and 2010.”
“Why has this happened? Because there hasn’t been a prolonged inventory rebuild. We haven’t really seen manufacturing and corporate capex pick up yet.”
“The question is, can the US reverse this trend, and pull off a sustainable recovery. Although the last US GDP number was revised down to 2.5 per cent owing to weak government spending, both consumer spending and investment were better than expected.”
Dean has navigated her fund through the recent business cycle very well, which earned her FE Alpha Manager status in the latest rebalancing.
Performance of fund versus sector and index over 5yrs
Source: FE Analytics
According to FE data, Cazenove UK Opps is the third best performing fund in IMA UK All Companies – a sector with almost 300 constituents – over a five year period, with returns of 111.9 per cent.
It’s also top-decile in the sector over a one, three and 10 year period, as well as over one, three and six months.
Year-on-year performance of fund versus sector and index 2008-2013
| Name | 2013 (%) | 2012 (%) | 2011 (%) | 2010 (%) | 2009 (%) | 2008 (%) |
|---|---|---|---|---|---|---|
| Cazenove UK Opportunities | 21.41 | 33.3 | 1.3 | 20.09 | 34.49 | -23.29 |
| IMA UK All Companies | 16.7 | 15.05 | -7.04 | 17.53 | 30.4 | -31.96 |
| FTSE All Share | 16.98 | 12.3 | -3.46 | 14.51 | 30.12 | -29.93 |
Source: FE Analytics
The fund has also been one of the most consistent funds of its kind, outperforming its sector average and benchmark in each of the last six calendar years, including the current one.
“We’ve had very good performance which has been very pleasing,” she said. “We’ve been moving and shifting the right way, which is what we’re about.”
“Looking at how my portfolio is shaped, we are still pro-cyclical as we believe growth will be better, so we want companies that are operationally geared to benefit. We’re not as skewed towards these companies as early 2012 because the market has re-rated, and there is some complacency kicking around.”
“We’ve seen buying industrials and financials, because prices have come down a bit. If Japan and the US both succeed in getting some growth on the table, we could be in the sweet spot for these kinds of stocks.”
Dean isn’t anti-defensives, but says she is finding it difficult finding those that are cheap.
“In my own view, I don’t like to have too many stocks with high P/E’s in the portfolio, as they can fall quite hard,” she said.
In recent weeks, she has added Debenhams, Petrofac and the Innovation Group to her portfolio, and added to her positions in Alent – formerly part of Cookson Group – Morgan Advanced Materials, Melrose and DS Smith. Dean also added to her financials exposure, increasing her holdings in Ashmore, Barclays and Legal & General.
Cazenove UK Opportunities has a minimum investment of £1,000 and an ongoing charges figure (OCF) of 1.58 per cent. The fund has been one of the best sellers of recent months, more than quadrupling in size to £1.6bn in the last year alone.
All of FE Trustnet's articles will be focused on Cazenove today. In the next article, we speak to FE Alpha Manager Paul Marriage about the small cap stocks he's tipping for greatness.