Sector trends suggest optimism about economies opening back up, and thus rotation should continue, but it is unlikely we will see a straightforward recovery. Valuation matters more now than it did for most of last year, but we also need a near-term driver for sectors. Moreover, the US Senate run-off election victories for the Democrats mean the party now controls both the presidency and Congress. This result has reignited some of the Biden plays.
Key Themes to Start 2021
Fiscal stimulus: hopes of more money for immediate aid, as well as infrastructure projects, could support sectors such as Industrials and Materials, in the US and internationally.
Inflation: inflation is now investors’ minds, as reflected by US 10-year Treasuries breaking the psychological 100bps level and the move in break-even rates. This backdrop is helpful to Financials via bank margins.
Still a need for caution: while we favour cyclical sectors for Q1, there is still a need for some defensiveness. In the event of an uneven recovery, Health Care may help given its relative stability of revenues and quality characteristics.
Against this backdrop, our Q1 Sector Picks include Financials (US), Materials (World, Europe), Industrials (World, US, Europe) and Health Care (World, US, Europe).
Performance differentials for Q4 and full-year 2020 were narrowed following the sharp rotation in November and December, but were still very wide. Q4 performance was dominated by the rotation since vaccine announcements.
Use of sector ETFs did not pick up as much as expected before the US presidential election, but did increase as a way of playing the rotation.
Institutional investors reacted immediately to the better outlook after vaccine announcements by targeting the areas where they were most underweight and/or with a higher beta.