Sunday, March 24, 2019

Our Current Thinking On Financials and Industrials

Our updated narrative on two troubled sectors, financials and industrials:

To get the gist of what we were thinking a few weeks ago, here's the "bottom line" comment at the end of our 2/1 assessment of the financial sector:

Bottom Line: The overall health of the sector, the still positive economic setup, still low interest rates (if the economy is indeed okay, rates will continue to inch higher, benefiting bank margins), efficiencies to be gained (read technology) going forward, and remarkably cheap valuations has us feeling comfortable with maintaining a top sector weighting for financials going forward.

Here's this morning's update:
3/24/19 Update
Financial stocks essentially matched the broader market’s performance from last update until last week, when the bottom literally fell out. The main catalyst being the March Fed meeting where the committee decided that there’ll be no rate hikes whatsoever this year and that they’ll stop the balance sheet unwind in September. The focus on net interest margins, once again, trumps all else going for the banking sector at the moment. 
Question, should we drop our target allocation from the current 15%?
While there’s a clear argument to be made for such a move, my concern is that if I’m right on the overall macro setup, and there’s no protracted global trade war, the second half of the year will see optimism come back and the yield curve steepen (per the no rate hike commitment, and an exodus at the longer-end of the curve). A scenario that would have money screaming back into a sector that trades at a huge discount to the broader market. 
We’ll let this play out for a few more weeks, reassessing along the way. I expect strong rallies on any good macro news in the meantime.

Here's the summary from our 2/1 narrative on industrials:
Bottom Line: Given the still decent economic backdrop, the prospects for a U.S. infrastructure bill, the likelihood for improved trade sentiment (particularly with China) going forward, and attractive valuations, we'll maintain our 15% of equities target to the industrial sector, for the time being...
Here's this morning's update:
3/24/19 Update
Industrials were this year’s market darling through the end of February. Since then, however, renewed doubts over the details of a trade resolution with China and Boeing’s tragic second 737 crash in 6 months has severely dented the sector’s relative returns, although, at the moment, it’s still ahead of the broader market on the year. 
At 15 times forward earnings we’re looking at a nice discount relative to the S&P. And, despite (or perhaps “because” of) the recent global slowdown, the prospects for global infrastructure spending remain very high, and the political risk of a protracted trade war (anywhere) makes it still an unlikely scenario. 
We’ll maintain our 15% target for the time being. If I were reducing financials today, I’d bump up industrials with some of the proceeds…

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