Use market volatility to add selective equities exposure

Jun 9 2010 by Andrew Miller, The Journal

MAY 2010 will not be remembered fondly by equity investors. The MSCI World index fell a hefty 7.5% in local currency terms in May - the largest monthly fall since February 2009.

The old adage “sell in May and go away” is something that has been quoted to us with increasing frequency over the past few weeks, but is it sound advice?

Clearly equity markets have been hit by a large amount of negative news in recent weeks. The European sovereign debt crises, Germany’s unilateral action to ban short selling, the freak 1,000-point fall in the US Dow Jones index in early May and BP’s oil spill in the Gulf of Mexico have all raised investors’ concerns. However, while all of this has been taking place, economic and corporate data have remained broadly supportive.

Specifically, economic data releases continue to signal expanding activity, and while we have marginally downgraded our own outlook for European GDP growth, the US and Asia still look firmly on track to enjoy a relatively vigorous economic recovery.

Earnings and outlook statements from the corporate sector also point to recovering profitability globally – even in Europe. As we have mentioned in previous editions of this column, these developments are leading to further upgrades to earnings forecasts for this year, which support already attractive equity valuations. When assessed relative to both government and corporate bonds, equities look keenly priced following the recent sell-off, and, assuming the economic recovery remains on track, are likely to outperform other assets over the coming months in our opinion.

So in essence, we don’t believe it is sound advice to be selling equities: if anything, we would be using the current market volatility to selectively add exposure. Market volatility will not disappear overnight, but when it does – most likely prompted by a realisation that fears have been overblown, and that economic and profits growth is robust – equities should be able to make decent gains through the end of 2010.

In a sector context, all equity market sectors saw losses last month, and only three – industrials, consumer staples and consumer discretionary – are in positive territory for 2010 to date. Given the problems BP faces, it is of little surprise that energy was the worst-performing sector in May.

The best-performing sectors in the sell-off were the defensives – consumer staples, telecoms and utilities. As we expect equity markets to recover over the coming months, we don’t believe this trend will persist and indeed we would expect some of the more economically-sensitive cyclical areas of the market to lead the main stock indices higher. As a result, we see no need to change our sector strategy.

We are funding these positions from the fairly expensively priced materials and consumer discretionary sectors.

Elsewhere, energy and financials look to be very attractively priced, but they are cheap for a reason – sentiment is against them and earnings risk is currently higher than normal. As a result we remain neutral on these sectors, awaiting some clarity.

:: Andrew Miller is regional office head at Barclays Wealth