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Time to rotate out of crowded US defensives?

Cyclical stocks have become more attractive, argues Pinebridge Investments.
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Last year, US-China trade tensions and fears of a US recession and a global slowdown led investors to favour defensive stocks in the US and globally, according to Mary Nicola, Singapore-based multi-asset portfolio manager at Pinebridge Investments.

The defensive sectors, which include telecommunications, utilities and consumer staples, were also favoured by several investment firms, including Daiwa Capital and Hermes Investment Management.

However, current valuations of defensive stocks, particularly those in the US, have become less attractive.

“It is interesting to point out that consumer staples and utilities were trading at a similar P/E as information technology in the fourth quarter,” she said during a webinar organised by the firm.

Source: Pinebridge Investments

Nicola makes a case for US cyclicals, which she believes are more attractive. Cyclical companies include those that operate in the real estate, consumer discretionary, industrial and financial sectors.

“The intermediate-term valuations in our view suggests that there is still further room to grow for US cyclicals,” she said.

Nicola added that the macro-economic backdrop is positive for US cyclicals, given that the headwinds of 2019, such as recessionary fears and the US-China trade war, have dissipated.

Further supporting US cyclicals is that the manufacturing purchasing managers’ index (PMI) in the US has bottomed, according to Sunny Ng, New York-based mixed-asset portfolio manager, who also spoke during the webinar.

Cyclical sectors and the PMI are roughly correlated, so an uptick in the PMI should result in a corresponding rise in cyclicals.

“It is one of those areas that would benefit dramatically as you can see how sensitive this exposure is to manufacturing,” he said.

“US cyclicals were a position that we added to the portfolio back in September when we felt that we would see manufacturing PMI bottoming.”

Source: Pinebridge Investments

Both Nicola and Ng acknowledged that the coronavirus outbreak may delay the pick up of manufacturing in the US and globally. However, the firm believes that the impact should be temporary and that the global economy should catch up during the second half.

US cyclicals accounted for the largest exposure (nearly 20%) of the firm’s Global Dynamic Asset Allocation Fund, a mixed-asset product co-managed by Ng, according to the fund factsheet.

The Pinebridge Global Dynamic Allocation Fund

Source: Fund factsheet. As of 31 January 2020.

Brazil equities, UK mid-cap

Ng also singled out opportunities in Brazil and UK mid-cap equities.

“Brazil’s economy and currency tend to be linked to the inflation level. And in that context, its consumer price index [which analyzes inflation] has been very stable in the last several years,” he said.

While the country’s economic recovery has been slow, he believes that company earnings are growing faster.

“We have seen earnings grow at significantly faster rates than overall GDP. That is because margins can expand quite significantly even if top-line growth increases a little bit,” he explained.

Turning to UK mid-caps, Ng believes that business and consumer business have bottomed out post-Brexit.

“Business confidence has been rising quite significantly. Return-on-equity has also bottomed as overall top-line growth has stabilised, which was the biggest drag overall on margins.

“In that context, it does appear that UK mid-caps appear attractively valued.”

Source: Pinebridge Investments

The Pinebridge Global Dynamic Allocation Fund versus its sector in Hong Kong

Source: FE Analytics. In US dollars. Note: the fund’s blended benchmark – 60% MSCI AC World and 40% FTSE World Government Bond Index, is not available on FE.

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