The markets are on the turn, but only in the short-term
THE success of Paul the octopus at predicting the outcome of World Cup matches has left many spread betters green with envy at his powers. What would be better than being able to predict with accuracy the bottom of the market? But in the absence of any psychic ability, traders have to rely on market signals, and one of them is beginning to turn fairly bullish.
The investment bank UBS has just started to see more net buyers of cyclical stocks than defensives for the first time since the market peak on 15 April. Typically, cyclical stocks outperform when markets are bullish, and defensives do well during periods of risk aversion. Analysing the pattern of investors’ behaviour suggests that they will continue to purchase cyclical stocks, which will fuel a market upswing, as it did from February to April this year.
BUYERS ARE COMING BACK
According to analysts at UBS, their clients have been buying stocks throughout the recent correction. Corporations have also become net buyers of stocks. So far this year they have bought $57bn of equities, which reverses some of the $147bn net selling of equities in 2009.
Fears of a double-dip afflicting the global economy are not enough to put investors off risk, at least not at this stage. This does not necessarily mean that investors are ignoring the global macro economic backdrop, just that financial markets often overshoot and can fall (or rise) too far. For example, the market sell-off over the past couple of months suggested economic armageddon was just around the corner, when that does not appear to be the case. When this happens a period of reconciliation is needed to recalibrate the financial markets back to something close to economic reality. Spread betters should look to trade these “recalibration” rallies.
CAPITULATION POINT
So how do you know when markets become oversold? UBS says that two weeks ago it saw the biggest net selling by hedge funds and long-only funds since the fourth quarter of 2008 – the peak of the financial crisis. It calls this the “capitulation” point and it signifies when markets became oversold.
But is this data really representative of the market? Of course it is only from one investment bank – however, it’s nevertheless a good gauge of overall market activity. UBS is the tenth largest investment bank in the world, and its assets under management in 2009 were $159bn.
So where should spread betters be investing? UBS clients have just become net buyers of the construction sector and net sellers of miners. Other sectors gaining attention include consumer discretionary – a traditional cyclical sector – along with food retail and chemicals. Big firms are also coming back into fashion. UBS clients have been net buyers of large cap stocks over small caps, which is a reversal of the main trend this year, when mid and small caps were favoured.
And it’s not just UBS that is positive on the outlook for stocks. Gartmore, the fund manager, is biased toward equities and does not believe there will be a double-dip for the UK economy.
However, as the chart shows, UBS investors have been going in and out of risk since the onset of the financial crisis in the autumn of 2008. This suggests that markets will remain volatile. These conditions require investors to be nimble, and spread betters should be disciplined about short-term trading strategies.