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Key Points
- The future expectations component of consumer sentiment offers contrarian opportunities.
- Sector rotation adds value — offense and defense still appear most prudent for portfolios.
- Important themes inside sectors offer the best opportunities currently.
Consumer sentiment gets reported on a monthly basis. This data is helpful to determine what current and future consumer behavior might look like. The data can also be fickle, however. Last week’s report showed a slight improvement from April, while still being below trend. Looking at the chart below from Dwyer Research shows sentiment may have bottomed for now and we should see slight improvements going forward. What I like to focus on, however, is the future expectations reading.
With so much uncertainty regarding job security, the unemployment claims rising, and the economic effects from the Covid-19 virus, the future expectations plunge was not unexpected. In my experience though, when expectations plunge, it’s usually a better contrarian indicator from an investment perspective. The current expectations component fell to levels not seen since October 2013. Before then, the indicator plunged even lower in the fall of 2011 as well as the fall of 2008 and early 2009. All of those dates tended to be pretty good times to fade the uncertainty and own more stocks. No one can predict the future but if history is any guide, buying stocks on the inevitable dips still should be rewarded. This is the most perplexing and hated market I have seen in 26 years. It’s also confirmed by the roughly $5 trillion in money market funds earning nothing.
Last week’s reading is similar to the October 2013 reading. The S&P 500 gained 25% over the forward 1 year when forward expectations were this low.
Source: Stockcharts.com
Sector and industry rotation can add significant value
I think it’s fair to say there has never been a time with more uncertainty in this country. With high uncertainty comes higher than average volatility across indices, sectors, and industries. For passive ETF’s and active funds that tend to be more static in their allocations and forced to stay in one style box, that’s a nightmare. For active managers that are willing to adapt and rotate through sectors, styles and stocks, it’s a wonderful opportunity to add value to the portfolio. Logic dictates in times of high uncertainty and with volatility spasms, more portfolio flexibility is better than less. Please make sure you have enough exposure to flexible strategies in the current environment. I wish I could say I have a high degree of confidence in seeing the uncertainty easing but my crystal ball is decidedly murky warranting a continued flexible and rotational approach to managing equities.
This is what a sector rotation looks like
Our team started managing the Dynamic Brands strategy in September 2016. We have a significant amount of data that shows where the alpha was generated, and this color chart shows one of the key ways added value can be created is by being willing to rotate across sectors as well as between offense and defense. The chart below is taken from the separately managed accounts research report ending 4/30/2020.
While the chart is a bit noisy, there are a few things to focus on. Looking at the above chart, naturally you would expect a global consumption strategy be persistently overweight the Consumer Discretionary sector (yellow and at the top) but we certainly have been willing to dial up or down that allocation according to the opportunities we saw in consumer spending brands. The Technology sector has also been a large sector allocation decision but has tended to expand and contract at different times over the last four years. The primary message here: each color has been wider or more narrower indicating the willingness to rotate through sectors during different periods of time. You can’t win if you don’t play.
Using cash to your advantage
One of the most important ways a flexible manager can try and buffer downside and add value to overall returns is by being willing to dial up and down the allocation to cash. Cash is absolutely an asset class when used appropriately and tactically. To use an analogy, when there’s no traffic, it’s less risky to play in the street and during rush hour, it’s prudent to get to the sidewalk. The same is true of holding cash. In today’s market and with high uncertainty, having cash on hand to take advantage of short-term pullbacks adds a differentiated component to a portfolio. The image below highlights an example of how one can use cash in good and difficult times in an effort to smooth the ride for investors. The blue indicated the level of equity investment and yellow the cash weight at month end. Cash equals opportunity.
As a long-term investor managing for short-term uncertainty, portfolio allocations currently look for a blend of offense and defense. If the situation changes to the positive, less defense is required. If things change and get more negative, more cash and more defense will be required. This is simple common sense and having prospectus flexibility allows the team to adapt to the inevitable changing conditions.
Themes to consider
I have written many times in these blogs our current preference is for e-commerce leaders, those brands that have a strong physical with attractive store aesthetics as well as having a solid digital business. Having this “omni-channel” capability has offered brands the ability to continue selling their products with the economy mostly shut-down. Significant amounts of continued technology spend via Cloud deployment and others will be needed across consumer companies and other industries. The digitization of corporate America has now been accelerated with the Covid-19 economic crisis. Work-from-home has also been a theme of interest. Not just for a temporary trade but as a new way of running businesses. A few companies were trending in the direction of allowing some employees to work from home and now that trend has gone parabolic. On the margin, more corporate office space will be available, and companies will increasingly do more with less space. As aggregate revenue spends time lower for a period of time, the companies that radically cut costs and rationalize real estate footprints will continue to show better profit metrics. The aging society and the need for vital healthcare innovation will continue to be a theme we are involved with. Humans are living longer and the need for healthcare, med-tech and bio-pharma will continue to be high. Streaming video and audio will also continue to be in-demand and remains a key theme for portfolios.
Preferred sectors
Based on the above thematic interests, our preferred sectors currently are Consumer Discretionary, Technology and Healthcare innovation. As a reminder, brand relevancy drives the stock selection in portfolios. Our brand relevancy scoring system helps us identify which brands have high brand love, loyalty and strong financial metrics. We are paying specific attention to the best balance sheets and cash generators in today’s uncertain market.
The Bottom Line:
Here are some bottom-line takeaway points for investors to consider:
- Consumer sentiment appears to be making a trough.
- The future expectations component of the consumer sentiment report tends to offer contrarian opportunities at extreme readings like it is today.
- Sector rotation and flexible mandates are ideally suited for today’s uncertain market.
- Using cash for tactical trading opportunities can offer significant value when volatility is high.
- There are numerous opportunities currently from the consumer spending thematic.
Disclosure:
This information was produced by and the opinions expressed are those of the author as of the date of writing and are subject to change. Any research is based on the author’s proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however the author does not make any representation as their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. There are no material changes to the conditions, objectives or investment strategies of the model portfolios for the period portrayed. Any sectors or allocations referenced may or may not be represented in portfolios managed by the author, and do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results.
