Campanology, the art of analysis

Despite the best efforts of the IMF to talk the UK economy down in the past week, one gets the sense that the underlying sentiment is improving towards the UK economy. The continued recovery in sectors such as the property shares and the housebuilders is an example. Aberdeen Asset lifting the gate on their commercial property fund is another sign that calm is returning. On Friday we get the results of the Markit Purchasing Managers surveys for June. Expectations are for a sharp fall in the indexes, these readings may give a better sense of the impact. Despite what felt like a slightly churlish move at this time by the IMF to slash growth expectations, it may be worth noting they still anticipate economic growth in the UK will outstrip that of Europe in the coming year! This is despite all the current stimulative measures the ECB currently use, with the promise of more if needed.

Miles Johnson in Thursday’s FT reports that Goldman Sachs have produced a research paper proposing that the current environment of low rates, low inflation, is an environment that investors should look for “bond proxy” stocks to invest in. Telecoms and Utilities are two they highlight. Brokers research has at times a habit of ringing the investment bell, could this be another occasion? When the oil price was approaching $140 in 2007, Goldman anticipated it could go to $200, is one example, ding ding.

These “bond proxy” sectors have been the strongest performers over the past few years for this attractive feature in a low growth world. Bond proxy sectors are also known as growth stocks, as their earnings should grow despite the economic environment, and hence their dividends. Electricity companies as an example - we have to turn on lights in periods of recession as much as economic growth, though we may be a little more circumspect about turning them off in the poorer times. We need dishwasher liquid in all economic conditions is another example.

Merrill Lynch’s fund manager surveys continue to show fund managers are already playing this theme as they are overweight growth sectors, for example consumer, pharma, utilities. They remain underweight the value sectors, particularly energy and materials.

The performance of the bond proxy sectors has been so strong that we highlighted a research report earlier in the year that the valuation gap between growth and value, (those stocks more sensitive to economic growth), produced by UBS, has not been wider between the two since 2003. It continues to feel that bond and equity investors are becoming complacent about bond yields and inflation, that is usually the time to be wary of a left field shock.

After such a strong performance in bonds and with yields little room to fall much further (in theory), any shift in sentiment towards bonds could see these bond proxies sold down quickly, as fund managers unwind these overweight positions. Should the Federal Reserve raise interest rates next week, could this be one event that will shake sentiment? 

Posted on July 21, 2016 .