On an almost daily basis, leading investment banks and brokers produce a veritable torrent of research notes. Such is the scale of their production that even after a judicious and regular audit I have many hundreds of these reports in my inbox each month. Most of which are sadly destined to remain unread…
However, there is one type of research note that I am almost certain to look at when I receive them, and will more than likely read fully. That class of note is about strategy or asset allocation. Equity research has had its reputation sullied over the last 15 years most notably after the internet bubble burst in the USA in the spring of 2000 (take a look also here on page 26 – http://issuu.com/spreadbetmagazine/docs/spreadbet_magazine_v14_generic where we PROVE that analysts are frankly worse than useless re their original intention but, very useful when doing the opposite of!). When regulators picked over the bones of the “madness of the crowds” they found that many leading analysts had written effusively on a stock and sector whilst harbouring or voicing much more negative views on those same stocks. Conflicts of interest abounded and pressure was applied across Chinese walls from corporate finance and broking departments who were more concerned about their fee income than presenting investors with the true facts and earnings potential of the early internet stocks.
Of course, since those revelations and the subsequent disciplinary actions that followed, the industry has cleaned up its act considerably. Sure, not every analyst was guilty of misrepresentation; in fact it was a just a few bad apples. Nonetheless, it’s still very rare to see a sell recommendation on a stock from a broker or bank that has a corporate relationship with that same business.
However, strategists at the leading securities houses are not constrained by such issues. Their views are often based on empirical macro factors and they usually adopt a top down approach to their research looking at geographical regions, individual countries, their economies and currencies, before addressing indices, sectors and only at the last, if at all, individual stocks.
These reports are generally unavailable to general public for a host of compliance reasons and as such, are the preserve of market professionals. However major calls from the leading banks and brokers are usually reported on in the financial media allowing the investing public to benefit from the accumulated wisdom of the brightest minds in finance. Over the past fortnight we have seen the publication of at least four influential strategy notes from Merrill Lynch Bank of America, Goldman Sachs, JP Morgan Cazenove and Nomura. All of which have plenty to tell us about the way ahead of for equities and other markets but none I feel had the complete picture nor were they in agreement with each other.
Two weeks ago Merrill Lynch BOA published its monthly Fund Managers survey a long standing Q&A based study that harvests the opinions of more than 230 participants and who manage a collective $640 billion dollars plus.
The survey seeks to identify changes in attitudes or developing trends in asset allocation and strategy amongst these managers. One of the key factors identified in this month’s report was a sharp reduction in allocations to EU equities across a wide of range sectors including financials, global cyclicals (exporters) and those sectors with predominantly domestic European earnings (Telcos Utilities etc.). Asset allocators did not exit these areas completely however, but reduced their overweight or excess exposure to these sectors by half. At the same time allocations to global equities as a whole rose to more than 50% overweight versus accepted benchmarks. But since cash levels also rose it seems likely that this extra allocation was a result of the continuing rotation out of fixed income and into equities.
The survey noted however that 44% of those questioned felt that EU equities were cheap based on current valuations – a figure not seen since the autumn of 2012. This suggested that in their minds, fears over European earnings growth were to a large extent priced in.
However it remains to be seen if that view is correct given recent profits warnings at two of Europe’s largest exporters – engineering giant Siemens and the Chemical behemoth BASF.
It may be that these are isolated incidents , however rival bankers Goldman Sachs felt it appropriate to direct their clients towards stocks in both Europe and the UK that had a domestic or developing market bias (as far as revenues are concerned) in their strategy note published just under a week ago (although as regular readers will know, it pays usually to do precisely the opposite of what “The Squid” says!). The bank noted the relative out performance of domestic oriented stocks, in the UK in particular, when compared to those with a reliance or position in the Emerging markets (for the UK one can read resource stocks here). Goldman’s view is that Emerging markets have peaked and that developing markets, led by the US and a stabilised and recovering Europe/ UK will produce the best returns over the midterm.
The US banks favour the UK (ex the resource sectors) over export lead markets, such as Switzerland. They were not alone in their current dislike of the resource sector, as we saw two days ago when Nomura published a note suggesting one should be underweight the UK versus European equities. That view was based on the overexposure of the UK to the resource sectors, whilst at the same time having little or no weighting in Luxury Goods or Autos. In the UK six of the top 15 stocks, when ranked by market cap, are drawn from the extractive industries and we have just one stock in the top flight in the Luxury Goods area and just a single representative across the whole 350 index in the Automotive sector.
JP Morgan took a different approach when its strategists wrote on the 26th of July. They cautioned investors not to place too much credence on data about monetary flows into individual stocks and sectors suggesting that overall this is a zero sum game with a willing seller for every buyer and vice versa (I would disagree with that statement to some extent because I think it ignores the effects of stock borrowing, derivatives and products such as ETF’s). Furthermore ,they encouraged clients to finesse any trading they did undertake based on flow data by, for example, buying and selling what is being bought or sold i.e. where positions are being built rather than those stocks where there are already large under or overweight positions i.e. crowded trades.
One area I can agree with JPM on is the emphasis they place on momentum or price action, a subject that I shall return to in a future article. JP Morgan’s view was that solid fundamentals, earnings growth and inflation will always be reflected in both absolute and relative price action confirming the efficacy of two old adages (if we were in any doubt ) namely that trend is your friend and cream rises to the top.