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Will the Sector Rotation Continue?
Amid a strong rise in equity markets in November, many sectors gained sharply given the positive implications of an effective vaccine. While value sectors jumped last month, we see a greater fundamental case for certain cyclical sectors, including Industrials, Materials and Consumer Discretionary, when we look ahead to sector opportunities in the coming months, as vaccines are rolled out.
We saw a sizeable rotation in November (across equity sectors, regions and styles). The big question is, will this turn in relative performance and flows continue?
The answer is probably yes, given the game-changing announcement(s) of an effective vaccine against COVID-19. Market sentiment is now focussed on economic recovery in 2021; accordingly, the rotation could continue through December at least, as investors cover underweight areas and position for next year.
Investor activity in the last month once again showed that sectors serve as a helpful vehicle to play beta during a rapid market change. Note the significant dispersion between sector returns in November, which created a huge opportunity for sector selection, and the absolute returns. For example, there are very few country or factor indices that came close to the Energy sector’s rise. Read on for our thoughts on opportunities in cyclical versus value sectors.
What We Saw in November
All sectors rose in strong equity markets during November, but there was a sharp change in relative performance from 9 November. On that Monday morning, stock markets learned that Joe Biden had likely won the US presidency, albeit without the expected blue wave, which could have brought more progressive policies such as corporate tax rises and health care reform.
Before US markets could open to react, we had the fantastic news from Pfizer* and BioNTech* of an efficacious vaccine. There was an immediate boost to sectors that had lagged most of the rally year to date, because they were greatly impacted by COVID-19 restrictions and/or because of the market demand for growth.
Since then, Financials and Energy have been top performers worldwide (see Figure 1 below), benefiting from their value characteristics. Meanwhile, defensive sectors such as Utilities and Consumer Staples underperformed.
Investor flows have largely matched the trends in performance. State Street Global Markets informs us that the vaccine news prompted institutional investors to start buying value stocks in preference to growth stocks. There has been a particularly marked catch-up trade in the Energy sector, along with industries including banks, airlines and hotels; these trends have accelerated according to the most recent figures.
Interestingly, much of the relative inflows have gone into areas of large underweight positioning. Rather than outright selling of stocks elsewhere, it appears these large, longer-term investors have been reducing cash balances given a new wave of confidence.
Looking at sector ETFs, we see the same trend in European-domiciled and US-domiciled ETF ranges: heavy inflows, little selling in any particular sector, and investors favouring Financials, Industrials, Energy and Consumer Discretionary. For more information on sector performance, flows and investor positioning, please see our December Sector Compass Monthly Update.
Investing in Cyclical Rather Than Value Sectors
The largest flows and performance moves have been in the value sectors of Energy and Financials, and previous short positioning suggests we could see further sharp moves. However, we prefer to think about the cyclical sectors as a way to position for the reflation argument, as we see a stronger fundamental case.
Among the cyclical sectors that could benefit from better economic growth are:
Industrials. A pick-up in business confidence and investment spending should result in new orders for machinery and engineering solutions. The sector has exposure to the expected bounce in travel demand through airplane manufacture and airlines (higher in the US than European index), as well as gearing to PMIs through logistics, construction and infrastructure.
Materials. The sector offers an equally diverse grouping that contains mining (higher exposure in Europe than US index), which should benefit from the recent surge in industrial metal pricing, e.g. copper and iron ore. The largest weight is chemical manufacturers, a group of companies that provides essential, speciality chemicals and gases for many industrial processes.
Consumer Discretionary. The sector contains the businesses that have been hardest hit by enforced social restrictions brought about by COVID-19. Restaurants, retailers and leisure providers (e.g. casinos and cinemas) should all gain from looser mobility rules once the vaccine is delivered. Online retailers have benefited from changes in consumer behaviour this year and could lag the economic bounce-back. For this reason, we would make a differentiation between the European sector, which has higher exposure to auto manufacturers and luxury goods, and the US and World sector indices, which have a high weighting to Amazon*.
How to play these themes:
SPDR offers a range of ETFs that allow investors to access exposure to the cyclical themes described above. To learn more about these ETFs, and to view full performance histories, please follow the links below:
SPDR MSCI World Industrials UCITS ETF (WIND)
SPDR S&P U.S. Industrials Select Sector UCITS ETF (ZPDI)
SPDR MSCI Europe Industrials UCITS ETF (STQ)
SPDR MSCI World Materials UCITS ETF (WMAT)
SPDR S&P U.S. Materials Select Sector UCITS ETF (SXLB)
European-Domiciled ETP Segment Flows(Top/Bottom 5, $mn)
European-Domiciled ETP Asset Category($mn)
Sources: Bloomberg Finance L.P., for the period 26 November – 3 December 2020. Flows are as of date indicated and should not be relied upon as current thereafter. This information should not be considered a recommendation to invest in a particular sector or to buy or sell any security shown. It is not known whether the sectors or securities shown will be profitable in the future.
* This information should not be considered a recommendation to invest in a particular sector or to buy or sell any security shown. It is not known whether the sectors or securities shown will be profitable in the future
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