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Image: How I Learned to Stop Worrying and Love Defensive Sectors


How I Learned to Stop Worrying and Love Defensive Sectors

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The title of our report is inspired by Stanley Kubrick’s fantastic 1964 film Dr. Strangelove, which satirises Cold War fears of a nuclear conflict between the US and the Soviet Union.

The film remains highly relevant today in the context of major geopolitical tensions, which do not appear to be taking a turn for the better. Our intention in this note is also to shine a light on “boring” defensive sectors such as Food and Beverage, Telecommunications, and Utilities, largely disregarded in recent years and on which we are currently Overweight.

Trendless and disrupted markets

  • Market conditions remain challenging, with long-term yields still rising. The move was briefly interrupted by the conflict in the Middle East, but regained momentum after the latest US inflation releases. Last week, strong US retail sales for September and ongoing concerns over the US fiscal outlook kept bond vigilantes on alert. In the coming days, the first estimate of Q3 GDP in the US is expected at above 4% (annualised)! There is no time for downtime. From a cross-asset perspective, we reduce cash in favour of gold as geopolitics might not get better any time soon. However, we refrain from being more aggressive on gold as the opportunity cost versus real Treasury yields at 2.5% is significant.
  • It’s dark and fixed income markets are wearing sunglasses. This pessimism is rational, since high bond yields have dramatically changed the narrative for the growth/tech darlings of the last decade, which have such an elevated weight on global equity indices. But it also looks overstated. We have huge debates within the team regarding the potential for a multi-year turnaround for the value/growth theme (we are Overweight value for the sake of it). This is tantamount to answering the question of whether yields will stay high for several years to come. But estimates of long-run neutral policy rates suggest they are set to remain low, at near 2.5% in the US and 1.5% in the euro area (link).
  • A revealing indicator of trendless market conditions is the performance of systematic trend-following strategies (NEIXCTAT Index), which is virtually flat both YTD and since end-June. Commodities and the US dollar have been the only asset classes delivering positive returns both last week and in the past three months.

What might change the market sentiment in the short term? Signs that the US economy is cooling down would ease the pressure on yields and on equity markets on the back of current correlation regimes. We are unlikely to see easing geopolitical tensions, though this would certainly prove helpful to bring down oil prices. It will take time before the easing of US sanctions on Venezuela can boost oil production, but the recent steps taken in this regard could contribute to bringing down oil prices/lowering bond yields.

What to do in this context? This is not the time to make huge directional bets, which can backfire swiftly. Taking advantage of the current level of yields to lock in the carry for the long term is appealing, as elevated bond yields carry the seeds of their own demise, i.e. the potential to bring forward the recession.

  • We thus reiterate our somewhat defensive stance published in early October (slightly Underweight equities, slightly Underweight bond duration, reduce credit risks and favour defensive sectors in equities: Telecommunications, Utilities, Health Care.
  • This week we focus on our Overweight stance on Pharma & Biotechnology in European equities. The sector ticks several boxes: it is defensive (earnings predictability is high), it has a strong balance sheet (low net debt/EBITDA), and it is positively correlated to the US dollar. Lastly, outperformance excluding Novo has been moderate over recent months, which leaves upside potential in our view.

Week ahead: Earnings season to kick into a higher gear. 169 companies listed in the S&P 500 will report earnings next week, of which Apple, Microsoft, Amazon, Alphabet, Meta. In Europe, 115 companies listed in the Stoxx Europe 600 will report earnings, of which half will be industrials, materials, and financials (Barclays, Santander, Deutsche Bank, UniCredit, BNP Paribas, Amundi).

On the macro front, preliminary PMIs and the ECB monetary policy meeting will be important drivers, though PMIs have lost their shine, and the ECB is unlikely to take any meaningful decision.

Asset classes performance (1 week)

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