The Multi-Asset Research team at Source, one of Europe’s largest providers of exchange-traded funds, has released research asserting their views on tactical sector allocations for the remainder of the year.
Cyclical ETFs, particularly consumer discretionary or industrial goods & services may outperform, according to Source.
The report analyses the global economic climate as well as regional conditions, both within local economies and their asset markets, in a bid to select sectors that may outperform in the US and Europe. These strategic allocations may be implemented quickly and at low cost through the use of ETFs.
Source noted the underperformance of equities relative to other asset classes in the third quarter, citing fears about a Chinese hard landing as its most influential factor. Despite global volatility remaining elevated, Source expects equities, real estate and high yield corporate bonds to outperform government and investment grade bonds in the final quarter of the year.
Source argues that different metrics should be applied when valuing the US and European markets. This is due to differences in how stocks have traditionally provided returns to investors in the two regions. European companies have historically provided larger dividends than US firms and investors should therefore place greater emphasis on dividend yield when valuing stocks. In the US, Source prefers to use price-to-cash flow ratios in their valuations.
Based on these factors, Source are more bullish on the European market as a whole than on the US. Paul Jackson, Head of Multi-Asset Research at Source, commented: “The European market requires dividends to grow by only 0.5% per annum to justify current equity valuations.”
Commenting on targeting specific sectors of each market, Jackson said: “Overall, our analysis shows that banks and resource-related sectors are some of the cheapest in both the US and Europe, while defensive sectors are currently among the most expensive. Utilities, a stereotypical defensive, is also the most leveraged sector in Europe, with net debt of 3.2 relative to EBITDA.”
“Cyclical sectors that may be worth considering include consumer discretionary in the US and European media companies, as well as industrial goods and services in both markets.”
The paper also tips financials as a potential outperformer in both markets, noting that valuations and price momentum are both particularly attractive. The exception in the US is financial services where expected business profitability is not as attractive as historic levels.
With sector-specific ETF suites being offered through a range of providers including Source, State Street Global Advisors, Lyxor, Deutsche Asset & Wealth Management, iShares, and Amundi, investors have plenty of options to obtain tactical exposure based on these predictions.