Let's make it easy
Global equities continue to mock the bears. The MSCI World was up 2.6% on the month in January, comfortably outperforming yours truly, which had to contend with 1%. The MSCI World is now up a cool a 8.1% since November, and while we saw faint signs last of weakness last week, it was really only a minor flesh wound for the bulls. Indeed, Friday's NFP number was a real treat for everyone. A solid headline and a poor wage print equal goldilocks and joy for both bond holders and equity bulls. As so often before, Spoos and Blues carried the day.
Last week I said that my valuation scores and stock-to-bond ratios are forcing me into a defensive position on equities. They also suggest that I should be buying bonds, or holding cash, rather than adding exposure to equities. That view hasn't changed. On the other hand, I am seeing nothing in my short-term indicators to signal that the market is about to take a dump. Equites have had a good run and volatility is low, but that in itself is not a reason to get bearish. Indeed, I was fascinated by a note from JP Morgan this weekend arguing that that net supply of global equities turned negative last year, and that they expect it to remain close to zero this year. This is happening in a situation where retail investors have turned sceptical about the veracity of the bull market. Clearly, this structural story is not a recipe for a massive accident, but rather for a persistent grind higher.
Instead, I think the key theme for asset allocators—as I argued a month ago—is to look within sectors. And here, the story is getting increasingly interesting. Whatever the medium-to-long run merit of the reflation trade is, my first chart shows that investors would be wise to curb their enthusiasm slightly.
If we break down this story, a number of juicy pair-trades are now on offer for long-short investors. The first chart shows the trailing y/y returns of consumer discretionaries and staples relative to materials, and the second shows relative returns for healthcare versus an equally weighted average of energy and materials. The message is clear; forget about trying to capture the twists and turns of the Spoos or the Dow; it's all about sector rotation.
The MSCI World is not equal to the U.S. stock market—although the correlation is close—but you would think that a couple of long-short GICS 1 sector strategies in the U.S. would do nicely now. Vanguard, incidentally, has ETFs for all of these in the U.S., so it is manageable to put this on without shorting single names. How about long VDC US equity and VCR US equity vs VAW US equity, or VHT US equity vs VAW US equity and VDE equity. As far as "risk neutral" strategies go, I would put them on the top of my list for the next six-to-12 months. In the portfolio, I am not really a fan of too many shorts as my brokers don't allow me to borrow shares, and I prefer to hold cash as the quintessential call option on volatility . I am long healthcare, however, via the IXJ ETF, and some mid-cap U.K. healthcare providers with exposure to the U.S. I am betting on this core position to win the day for me.
In other news, last week was a relatively calm one for the White House, which is important for a market watching every move of the new U.S. administration. Sure, the inept handling of the immigration executive order continues to make waves. President Trump is taking on the judiciary, which is always sensitive in a system built on the separation of powers. In addition, the baffling reference to a massacre that never took place by Kellyane Conway, a senior advisor to President Trump, provided plenty of fodder for the anti-Trump crowd. But the pivot towards a clamp down on regulation revealed a different side of Mr. Trump's team, which is more in tune with investors. The gung-ho attitude to regulation reduction is a little bit worrying given that these rules were forced on financial markets to avoid a repeat of the financial crisis. But I don't know enough about the specifics here to have a clear view. In any case, the short-term boost to markets from de-regulation shouldn't be underestimated.
More generally, those of us who mainly spend time in the anti-Trump echo-chamber should be careful. We should continue to object to political moves we don't agree with. A case in point is the obsession with U.S. bilateral trade deficits compounded by the work and, I assume, advice of Peter Navarro. I am going to have a more in-depth rant here later, but I am increasingly convinced that Mr. Navarro has no clue about the subject matter of which he is in charge. Or let me put it this way; he has a very one-sided view of international trade, and I wonder whether he understands BOP accounting at all. This is likely to generate a lot of political volatility going forward. But we shouldn't stick our heads into the sand.
I am sceptical that Mr. Trump is going to deliver on his promise to "make America great again", and I think that divisions are being sown that will be difficult to heal. But I have to remember that despite the catastrophic implementation of the "immigration ban," it is something that they specifically promised, even if it is draconian in the extreme. I don't agree with it, but what about the "majority"? UK PM Theresa May was criticised for not "condemning" Mr. Trump's order, but I wonder whether she should have. As an EU national in the U.K. following the discourse on immigration after the Brexit referendum, I suspect a majority in the U.K. would want Mrs. May to do something similar, if she could.
Meanwhile, if we hit the mental "unfollow button" in politics, the message in equity markets is relatively simple. Put your money in defensives, and take profit on cyclicals. Could it really be that easy?
 - Also, I am scrambling to finish and record part 2 of this, which is turning into a bit of a monster.
 - Bonkers you say. Well, rule number one for retail investors is to keep your money away from brokers/platforms that allow leverage/margin trading via synthetic futures, CFDs etc. And if you do, cash borrowing often is expensive.