Call #1: Overweight Healthcare
Call #1: Overweight Healthcare
This week, our attention turns to the recent slowdown in the global economy and what it means for investors.
Over the past month, both equity and commodity markets have staged a modest retreat. A large part of the weakness can be attributed to the palpable slowdown in the global economy.
One potential cause of the slowdown is the lagged impact of higher commodity prices, which have historically acted as a drag on growth. Over the past two years, industrial metal prices have more than doubled back to their 2008 peak. In addition, the recent spike in oil prices is further complicating the picture. Since the summer of 2009, oil prices have risen by approximately 65%, creating an additional drag on the discretionary purchases of lower-end consumers and on economic activity.
In the United States, a moderation in government stimulus is also fueling a slowdown. First quarter US gross-domestic-product expanded at an anemic 1.8% annualized pace, down from 3.1% in the previous quarter. This does not appear to be a temporary blip. The Chicago Fed National Activity Index, an indicator that has been particularly accurate at forecasting economic growth, also fell sharply in April. While the current reading does not suggest a double-dip or contraction, it does indicate that second quarter growth is likely to be closer to 2% than to the 3% estimate the market is currently expecting.
In addition, the weakness is not limited to the United States. Most economies – in both developed and emerging markets – are experiencing a similar deceleration. Particularly troubling has been the slowdown in China, until very recently the engine of global growth, as the government there tries to curtail inflation.
While we do believe that this global slowdown represents a deceleration rather than a reversal of the global recovery, we believe investors should consider moderating their views on future growth and adopting a more defensive posture.
From an investment standpoint, a slower global economy means slower earnings growth. While we still think the equity market can advance based on high margins, low interest rates and low inflation, the gains are likely to be slower in coming months and cyclical companies are likely to face more headwinds. As a result, we favor decreasing exposure to cyclical names and sectors and increasing allocation to more defensive sectors such as Healthcare, which we first talked about in this April blog post and also mentioned in our recent global sector commentary.
Call #2: Exit Overweight Australia
Late last year, we advocated an overweight to Australian equities, which we then reiterated in early April. Since the initial call, iShares MSCI Australia Index Fund (EWA) has gained around 6.5%, modestly outperforming the Global ACWI benchmark, and we are now changing our view to neutral for a number of reasons. (You can find standardized performance for EWA here).
First, Australia no longer looks particularly cheap compared to other developed markets. Second, inflation has accelerated over the past few months. In addition, the ongoing housing boom is leading to a pickup in mortgage delinquencies, which will negatively impact the banks. Finally, China’s effort to reign in its economy is leading to a dramatic slowdown in commodity imports, a negative for the Australian mining industry.
Potential iShares solutions
IYH – iShares Dow Jones U.S. Healthcare Sector Index Fund (click here for fund details)
IXJ – iShares S&P Global Healthcare Sector Index Fund (click here for fund details)
AXHE – iShares MSCI ACWI ex US Health Care Sector (click here for fund details)
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