| Global risks through the lens of the US equity market |
| 08.02.12 07:50 | |
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Our cautious outlook on the first half of 2012 was driven in part by the risk of disorderly European bank deleveraging with the potential spill-over into EM trade finance. Although concerns remain, these risks have thus far been contained, evidenced by stabilization in global PMIs, including Europe and EM, and further reflected in equity returns (SPX +6.9% ytd), particularly in sectors with direct exposure to these risks and safe havens bid up during the downturn. The easing of deleveraging risks is best illustrated in the performance of financials and materials, the top performing sectors ytd, both up 12.7%, despite having the sharpest reductions in 2012 EPS estimates (financials -5.2%, materials -6.1%). The market likely discounted these declines in advance of analysts' earnings revisions, particularly during the July/August sell-off. However, we believe the outperformance is primarily explained by investors assigning much lower probabilities to the global contagion tail risks at the core of the outlook for the sectors. The industrials sector faced similar EM downside and, like materials, the mitigation of these risks has led to significant outperformance (+9.6% ytd). We expected margin pressure this quarter, but, margins have held up with better-than-expected earnings and expectations have held in with firming PMIs. Long term, we are constructive on the group, but in the near term, we still view margins at risk. We believe changing fundamentals better explain technology's 10.4% performance. Heading into earnings season, the technology-heavy negative preannouncement ratio, (above prior cycle highs) and a series of poor earnings reports, helped reset expectations. However, 4Q results showed semi margin concerns were overdone, marking further stabilization in our margin dispersion index. We would be remiss to ignore the AAPL effect; without the increase in AAPL's 2012 estimate, technology EPS estimates would be flat instead of up 3.4%. Still, in contrast to its effect on earnings, AAPL added only ~90bp to TEC's total performance, highlighting broad improvements in the sector. Defensives underperformance has been driven by not only lower betas (lower exposure to a risk-on rally) and the drop in correlation, but also valuations, which were bid up as investors hid in safe havens during the recent sell-off. Utilities and staples were stretched, with fundamentals showing little scope for improvement, which helps explain these sectors' negative returns on the year despite the S&P being up 6.9%. Healthcare is the only defensive up ytd, despite poor performance from large cap pharma and mixed but generally negative analyst revisions across industries. Technology and energy still look favorable to us. Financials estimates continue to fall, valuations are not particularly compelling and policy hurdles remain. In addition, to the detriment of materials, EM central banks may not be as quick to reverse last year's policy tightening. Industrials could face a couple of quarters of margin pressure but may benefit from constructive tax and energy policy in the second half. The recent underperformance in defensives has left relative valuations across these four sectors much less stretched, staples in particular. For investors not comfortable with the S&P near the prior highs, a reallocation to defensives is now looking more attractive. source: BarCap |
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