It is a good time to alter sector exposure at the moment as many areas of the market are at a turning point, according to Fidelity multi-managers Kevin O’Nolan and Nick Peters.
The global macroeconomic picture is a mixed bag when it comes to growth, currency strength and economic health, with areas such as Europe and Japan boosting investor sentiment through monetary easing while stocks in China continue to sell off on a growth slowdown, with the biggest one-day percentage loss since 2007 occurring today.
Source: FE Analytics
Closer to home, the FTSE 100 rout has continued as the index fell to 5,995 points in morning trading, which is the first time it has been below 6,000 for more than two years.
Anna Stupnytska, global economist at Fidelity Worldwide Investment, says that while the biggest event this month has been the yuan devaluation, which has left investors guessing how markets will be impacted, investors are keeping an even closer eye on the Federal Reserve.
“Of course the main focus remains on the Fed as we approach the first interest rate hike in the US for the first time, possibly sometime this year,” she said.
“Over the past month, global growth remains relatively subdued, with developed markets still driving much of the momentum while emerging markets continue to lag.”
“Commodity prices fell to new lows, meaning that the low inflation environment is likely to last a little bit longer.”
While oil prices are continuing to drop, other materials such as gold, copper and aluminium have also tumbled in value as impending rate hikes could threaten to devalue physical assets.
Not only this, but the combination of material oversupply as well as tumbling demand in China, which is its biggest consumer market, has hurt the sector even more.
It is unsurprising that investors have turned pale on the sector, so why is the Fidelity multi-asset team increasing its exposure?
“Continued weakness in Chinese growth, dollar strength and over-supply in commodities has been weighing on both emerging market equities and the commodity asset class for the last few years,” O’Nolan said.
“The supply picture in commodities has started to improve in general and I’ve now got a more neutral stance on the asset class, but to continue adding from here and to start closing the underweight to emerging market equities, I’d like to see some evidence that activity in China has started to pick up or that the dollar strength trend has peaked out.”
Of course, the weakness in commodities has implications for equity regions beyond emerging markets and will have inevitably affected even the best-performing developed markets, through their large mining and oil & gas businesses.
Nick Peters, who manages a range of both multi-asset and regional funds, says the behaviour of the UK market has been interesting this year as investors attempt to reap the benefit of their home market and isolate global risk.
“What we’ve seen is that the smaller companies and mid-sized companies have outperformed the large-caps and mega-caps, and that’s really for two reasons,” he said.
“First of all, mid-caps are a more effective way of playing domestic growth and the UK growth picture looks okay, but also around 20 per cent of the FTSE 100 is exposed to commodities and so you’ve seen weakness there.”
“What’s been very interesting is that we’re seeing value managers looking very closely at some of those mega-cap stocks because they do look cheap and they do have yield support now.”
Performance of indices in 2015
Source: FE Analytics
In an article published last month, Lazard’s Alan Custis told FE Trustnet that he also sees more value in UK large-caps than he does in smaller companies.
“To get more constructive towards large-caps you have to be more constructive towards sectors or some of those sectors going forwards, and we are certainly getting more constructive towards mining and oil & gas, which in aggregate still represent 15 per cent plus of the FTSE 100,” the manager said.
“We are getting to valuation levels that we think are starting to get quite compelling. If we look at the dividend yields of Rio Tinto at around 5.5 per cent, BHP Billiton at 6.3 per cent, they’re obviously high-yielding stocks now in the context of the stock market overall.”
A factor that cannot be ignored in terms of sector allocation is the impending interest rate rise and the impact this will have on different regions across the world.
If the dollar were to remain strong after the Federal Reserve hikes rates, for example, US exporters would suffer and emerging markets could suffer a significant blow, as a majority of their debt is denominated in US dollars.
“Looking ahead, I think the outlook on the dollar is very dependent on what happens in terms of the path of interest rates, and there the growth picture is okay but inflation remains very muted, and there’s really no need for the Fed to be aggressively tightening from here,” O’Nolan explained.
“On that basis, it’s not particularly obvious that the dollar should continue to strengthen. Looking at previous cycles, the dollar performance has been relatively mixed when the Fed is hiking rates. The only real example is that we have of continued dollar strength when the Fed is tightening rates is in the early 80s.”
“Broad dollar strength may slow, but what we have seen is this renewed commodity price weakness, and that weighs on commodity producers. If we don’t see a bounce-back from current levels, I think you’re likely to see continued strength versus those currencies.”
Fidelity isn’t ruling out a turnaround in commodities in the near future, however, and Peters says the asset management firm is seeing the potential for turning points in a number of other sectors.
For instance, the multi-asset team has been taking profits in sectors such as consumer discretionary and technology because they have done well so far, but a rate rise could dampen consumer confidence.
“We’re looking more closely at sectors like industrials and, historically, the industrial sectors have performed well as rates have risen and on signs of improving economic growth,” he said.
“Also, the sector has underperformed and a number of the stocks are looking very good value at the moment.”
