Global Horizon November noise before the rally ::Macquarie Research,

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Global Horizon
November noise before the rally
Event
 Our last note, Revisions a coal mine canary too, showed that earnings
revisions and the OECD leading indicator (LI) can be effective timing tools. In
this note we look at the variation in sector returns going into, and coming out
of a trough in the OECD LI, as we have found this to be the more effective of
the two in terms of discriminating between sectors.
 Bond yields and earnings revisions will signal whether a rise in equities can
be sustained. So far bond yields are 50bps above the recent low, and this is
not yet sufficient for a strong upward move in equity markets. While the
majority of US companies have delivered good results, forward 12 month
revisions have continued to deteriorate, and as a result revisions are more
negative now than at the end of September.
Impact
 There is a marked variation in forward 6 month equity returns in USD when
the OECD LI is negative, with a median loss of 11% when this indicator is also
falling, and a gain of 20% when the indicator is negative and rising.
 With the OECD LI indicator currently negative and falling, we are in the worst
regime for equity returns. That said, the market is already down 10% since the
OECD LI turned negative, which is in line with the median 6 month return for
this period (after being down as much as 21% on October 4).
 Historically, the sectors that outperformed when the OECD LI is negative and
falling were Pharma & Biotech; Semiconductors; Food, Beverage & Tobacco.
Telecoms and Utilities have tended to underperform, which is surprising given
they are seen as defensive sectors.
 In his October 19th strategy note, Peter Eadon-Clarke argues a normal down
cycle in the OECD leading indicator lasts around seven months. With the
OECD LI going negative in July, he expects it to trough in January 2012.
 The sectors that outperformed most when the OECD LI is negative, but rising
were Semiconductors, Materials and Consumer Durables & Apparel. The
worst performers in this regime were Utilities and Telecoms.
Outlook
 Compared to the more stable environment when the OECD leading
indicator is positive, the decisions investors make when this indicator is
negative have the potential to make or break a portfolio’s returns.
 With the OECD leading indicator negative and declining, and with earnings
revisions suggesting this trend will continue, a bias toward defensive and low
risk seems justified. Unless there is a stronger growth outlook indicated by a
further sell-off in bonds, or a bottom in earnings revisions, we expect to see
more noise and range trading in November. December will likely be a better
month, as it is seasonally stronger, especially given the Chinese Year of the
Dragon starts in January. We therefore think December is likely a better time
to start positioning for an upturn in the OECD leading indicator.