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It's all about the sectors
As economies and central banks around the world move in lock-step capital allocation by sector – rather than region – should prove a more effective investment strategy.
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Which economy will grow faster this year: the euro zone or the US? Which central bank will surprise markets the most? Fund managers spend a lot of time debating these issues and their implications for asset classes in different regions.
But in fact, there hasn’t been much divergence in economic and monetary cycles for some time. As a result, differentiating between countries hasn’t really helped drive investment performance, with share price moves dictated more by individual companies’ earnings.
In this environment, we believe there are much better opportunities for alpha generation to be had from looking at asset allocation by global sector rather than by region. Both our market analysis and the attribution of our own portfolio returns support this view.
The average 12-week dispersion of returns within the MSCI All-Country World Index – the extent to which returns differ from the mean – shows that stocks are behaving more according to which sector they are in, on a global basis, rather than to which country or region (see chart). Indeed, this trend has been in place for much of the past three years.
Furthermore, the quarterly rolling correlation of share price returns among different regions is hovering around its long-term average. Correlation between sectors, in contrast, has been heading lower and now stands at just 52 per cent – meaning sector indices move in tandem with each other only around half the time – versus the long run average of 69 per cent.
relative importance
Dispersion of returns among industry sectors compared to return dispersion of regional equity markets, expressed as ratio
Source: Pictet Asset Management, Datastream. Data covering period: 02.07.1998 – 14.06.2018, using constituents of MSCI All Countries World Index, 12-week average
So, if sectors are the way to go, the next question is which ones to pick? We believe energy and materials currently offer attractive opportunities. We also like technology for the long-term growth potential, particularly in robotics and the digital economy. Conversely, we are fairly cautious on utilities.
Of course, economic and policy divergences may yet re-emerge. In the US, for example, there is support for Reagan-style supply side reform: lowering taxes in a bid to increase total budget revenues. It is hard to see such policies being passed in Europe, where strict EU rules necessitate greater control over public debt. The rise of populism can play a part in triggering divergences as populist parties are more likely to follow non-conventional agenda or focus on domestic priorities. That would lead to greater dispersion of returns and lower correlations in the performance of their respective stock markets.
For today though, sectors are in the ascendancy, and active managers have the opportunity to use this in asset allocation decisions to maximise returns.
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