Quick Global Equity Income View: Anatomy of a Sell-Off

 In Market and Investment Insights

Ben Lofthouse, Head of Global Equity Income, examines the effects of the recent equity market sell-off on European cyclical and defensive stocks.

There has been a sharp sell-off in the markets over the last few days. While painful for investors, there have been some interesting technical developments. Despite a market correction being widely expected, it has turned out to be hard to defend against because, in the main, defensive stocks have fallen as much as cyclical stocks.

The first chart below shows that expected performance based on beta has not been a good predictor for behavior during this fall. As an example, we would expect utilities to be down 5% and autos down 10% in a market correction (bottom axis), but according to the chart data, utilities actually fell 8% and autos slightly less than 7%, so autos outperformed (vertical axis).

Why have Defensive Stocks Fallen as Much as Cyclicals?

There are lots of reasons being given, such as positioning, funds flows and a low volatility unwind. But the most obvious is that this sell-off has been triggered by strong economic growth in the U.S. in the form of better-than-expected payroll and wage numbers.

Sector performance in Europe has deviated sharply from the “normal” beta-driven sell-off

lofthouse_chart_1
Source: Thompson Reuters Datastream, Goldman Sachs Global Investment Research as of 2/7/18.This chart is supplied independently by Goldman Sachs Global Investment Research. The views in this article are those of Janus Henderson Portfolio Manager Ben Lofthouse.

When Growth Surprises

The second chart shows cyclical underperformance during corrections in two different circumstances, when bond yields fell and when they rose. It shows that when there is real concern around economic growth (bond yields fall) then defensives are defensive, but when it is a growth surprise (bond yields rise) they offer less defense relative to the market.

What Happens to Cyclicals and Defensive Stocks When Bond Yields Rise or Fall?

lofthouse_charts_2.v2
Source: Thompson Reuters Datastream, Goldman Sachs Global Investment Research as of 2/7/18.This chart is supplied independently by Goldman Sachs Global Investment Research. The views in this article are those of Janus Henderson Portfolio Manager Ben Lofthouse.

We are some way through the cycle, and the relative protection an equity portfolio can provide against a real slowdown, or even just concerns about one, remains and will be measured by the exposure to cyclical companies. However, in the event of positive growth/higher inflation, this market reaction shows there might still be some over positioning in defensive areas.

Given that bond yields remain very low in Europe and Asia, we would observe that there could be more moments in which traditionally defensive areas within equities do not provide as much cushioning as investors might expect.

In the longer term, what ultimately always concerns us is a permanent loss of capital, not short-term market gyrations. This means not overpaying for or owning bad companies.

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