Equity Strategy: July Chartbook – Divergences are building, how will they close?

Speaker - Mislav Matejka, CFA, Head of Global Equity Strategy

The market is increasingly confident that the weak parts of the economy are set to improve, and that the good parts will stay resilient. In a sense, bad is seen as good: “China dataflow is so weak that there must be stimulus, manufacturing PMIs are so weak that they are bound to rebound”. This is producing an interesting divergence in the performance of Cyclicals vs Defensive stocks and the activity dataflow. Compared to a year ago, Cyclicals are up vs Defensives by 20% in Europe and in the US, but manufacturing PMIs and ISM are in contraction territory. Which one will end up right? There was another period when the divergence like this opened up – in 2007, with Cyclicals rallying despite manufacturing activity weakness, and Fed was then also at 5.25%, with the belief that they needed to do more, the same as now. Fundamentally, we think that bond yields will move back down, pricing power is waning, PMIs could indeed converge, but with services coming down towards manufacturing in 2H, as M1 suggests, rather than the other way around, and the hopes of a swift and meaningful China stimulus could remain just that, hopes. The market needs to resolve a basic disconnect: how will the Fed pivot if there is no pain? Bull-Bear has moved into positive territory, Vix is near record low and positioning has increased, there is no more safety net, FOMO is in full swing. Keep UW Eurozone in regional allocation, stay cautious on China, Japan remains our regional OW for this year. Preference for Growth over Value should remain a winning strategy in 2H.

This podcast was recorded on 02 July 2023.

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