Since 2011, most of the Equity market rally has come alongside with falling bond yields, and defensive equities have outperformed. However the rally of the last three months has not been led by defensives, but by cyclical sectors. US cyclical and consumer cyclical growth sectors have outperformed vs. defensive sectors. Not surprising given how strong the US data has been over this period especially after the q1’14 weather related slump. Even Chinese economic data has seen some reacceleration post its weak q1 boosting confidence recently. In Europe the performance has been essentially flat over the past 3 months and over this period defensive stocks have outperformed, similar to the rally over the past few years. This is in sync with recent weak data seen in Europe and concerns on sustainable cyclical growth and recovery in the region. But the breadth of the market has been weakening in the last few weeks, fewer stocks are making new 52 week highs; it is getting harder to hold down the fort.
As the macro economic data improved recently, with hints of Chinese stimuli in selective areas being introduced, base metal prices have rallied 7% on average in 1H14 and triggered a re-rating in the mining sector from the lows, failing to make new highs instead just yo-yoing in their trading range.
However, let’s not get ahead of ourselves…..
The rally makes sense in some selective Commodities given genuine tightness seen in their physical markets. We are not about to experience the rising tide lifts all boats scenario just yet. Sure the global growth pick up implies that the marginal rate of demand should move higher, but it is still not enough to soak up the supply side of the equation that has also been picking up and continues to do so. Prices will at best be in a trading range. A stock trading at a massive discount to its long term NAV is just not good enough a reason to invest in it anymore. Stock selection in 2014 is key unlike the cycle in 2004.
Given recent better US economic data, the FX markets have been toying with the idea of rates going up sooner than expected. This is causing a shift in yields in the front end of the curve and the USD has been rallying slowly against a basket of currencies. Emerging market currencies breaking lower does not bode well for their respective markets either. Q2’14 US GDP report showed 4% growth vs. consensus of 3%; a very good number driven by personal consumption +2.5% vs. 1.9% expected. The FOMC statement released afterwards tilted on the dovish side and markets rallied after the initial sell off, however the volatility is certainly not helping the large consensual levered positions in the FX markets.
“Houston, we [may] have a problem!”
