Source: Drew Angerer/Staff/Getty Images News
In 2016, we timed the portfolio shifts of the CF Canlife Global Equity and CF Canlife North American funds very well, rotating our overweights into the more value areas of the market as economic indicators – such as the Citigroup Economic Surprise Index – began to suggest that consensus views were too bearish. We were therefore well-positioned when the market realised that bond yields could not fall further, following decisions by the Bank of Japan (BoJ) and European Central Bank (ECB) not to go further into negative interest rate territory.
This was a significant benefit to the performance of both funds, as higher yields saw sectors such as financials, materials and industrials outperform, with the more defensive sectors selling off until year-end. However, as economic data began to soften in January, we moderated our approach and adopted a more defensive stance. Political and economic uncertainty saw bond yields head south once more and choppy markets were anticipated. US treasuries troughed at 2.14% in mid-June.
Growth > defensives > value
We had favoured defensives over pure growth stocks in this environment, with overweights to sectors such as consumer staples. However, it was pure growth stocks that ended up outperforming by 20-30% in the first half of 2017, with the FANGS (Facebook, Amazon, Netflix and Google) leading the way. As a result, the performance of the CF Canlife Global Equity and CF Canlife North American funds lagged their respective benchmarks. However, it also resulted in a realisation. Bond yields began creeping up on no news, for example, and we also had not seen the level of underperformance we would have expected from the financials sector. Often, the relative performance of US banking stocks is correlated to the steepness of the yield curve. However, as the below graph shows, this became disconnected in 2017. As the red line drops sharply between January 2016 and the end of June, you would expect banks to underperform the S&P 500 Index significantly. However, as the blue line highlights, relative performance has in fact held up well, dropping nowhere near as significantly.
Bank performance has held up well
Source: Bloomberg, as at 30/06/17.
A change in tack
Macro factors play a very important role in the funds’ sector allocation and stock selection process. As a result, our overweights to defensive sectors such as consumer staples were reduced significantly, whilst we added a number of banks, materials stocks and short-cycle industrials into both portfolios, in anticipation of better economic conditions ahead.
A repeat of last year?
The second half of 2016 saw a huge rotation in sector performance and we believe the same will happen again this year. Despite a number of economic and political uncertainties, global economic growth remains robust and we have seen markedly less dovish tones emanate from central banks in recent weeks. This leads us to think that we have moved on from a world of ‘just’ low bond yields, which should disproportionately benefit the more value, beaten-up areas of the market.
One example of a stock we have recently added to the portfolio is US Steel, which has been a strong performer for both the Global Equity and North American portfolios in the past. The company supplies steel to the automobile, appliance, industrial machinery, construction and energy industries and was first purchased in late 2016 to benefit from the anticipated infrastructure spending plans of President Trump. However, these plans became more uncertain, which resulted in us selling the stock for a more than 100% gain at the start of this year. With the stock now trading at less than $25 per share – down 30% year-to-date – and on an attractive valuation, we have re-initiated a position.
Although we do not expect any significant news on US infrastructure spending or new government programmes, we believe the market has priced in no action, which means that some newsflow should be positive for the equity market. In addition, with the expectation that yields rise modestly this year, value sectors such as financials and materials should continue to outperform. Therefore, we expect 2017 to play out much as 2016 did and believe that investors should be looking closely at value-focused funds in this environment.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Currency fluctuations can also affect performance. The contents of this article are not intended as investment advice.
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CLI00856 Expiry 19 July 2018