PORT IN STORM: Equities of the most economically sensitive US sectors, from financials to consumer discretionary, have lagged traditional defensives, like healthcare and staples, by over 10% this year (see chart) as recession and earnings risks have soared. This is a smaller under performance than history given the already deep relative valuation discount, shallow recession outlook, and nearing catalyst of peaked Fed interest rate expectations. With macro risks high and only a gradual U-shaped recovery forecast we keep a core focus on defensives, including big tech. But watch for select opportunities in cheap cyclicals, like banks and energy, as Fed pause nears.
CYCLICALS: These have been lagging for a year. Sapped by a rising drumbeat of recession worries. This has more than offset both low valuations and some improving fundamentals. From the benefit of rising interest rates for banks to the post covid reopening for discretionary. But profit misses, from Fedex (FDX) to Ford (F) to Carmax (KMX) been painful reminders of lower good demand and tighter financial conditions. But any recession relief would help and some risk /reward is attractive. Financials (XLF) are cheap, well capitalized, and helped by higher interest rates. Similarly energy (XLE) is the cheapest of all and to benefit from high-for-longer oil prices.
DEFENSIVES: Sectors from healthcare (XLV) to utilities (XLU) outperformed. Investors sought a haven from the rising recession risks in their defensive cash flows. This has outweighed the valuation hit they took from surging bond yields. Many defensive valuations are undemanding, like healthcare, even if the overall P/E premium to cyclicals is a chunky 40%. Tech (XLK) has been a anomaly. Most exposed to higher bond yields, given its high valuation. But with ‘big tech’ very well placed to weather a recession with its huge profit margins and fortress balance sheets.
All data, figures & charts are valid as of 29/09/2022