The Sector X-ray
Sébastien Page
Head of Global Multi-Asset and Chief Investment Officer at T. Rowe Price | Author: “The Psychology of Leadership” (Harriman House)
A sector X-ray provides insights into allocation decisions
“So, what’s going on in the stock market?” In this industry, you’re likely to get some version of this question whenever someone asks what you do for a living. The subject comes up at doctor visits, for example, especially when it involves highly paid specialists with big investment portfolios.
I never know how to respond. “Do you mean the Dow, the S&P 500, the Nasdaq? Do you also want to talk about small-caps? Or overseas markets? And can we please talk more about this after I put my shirt back on?”
Moreover, the answer has rarely been so complicated as it has been lately. Some parts of the market look expensive, some not so much. And the divergence in the performance of different parts of the market is striking by historical standards.
Here’s how I might put it to the doctor: Just like you can’t tell what’s going on with a patient in certain situations without an X-ray or an MRI or an ultrasound, sometimes you have to look under the surface of the market to understand its dynamics. Broad benchmarks don’t tell the whole story.
X-raying our portfolio
In our Multi-Asset Division, we manage over 350 portfolios, with a total of $466B in assets under management.1 In recent years, we’ve accelerated our pace of innovation. We’ve developed sophisticated derivatives overlays, absolute return strategies, and a wide range of custom solutions. And we’ve expanded our capabilities to actively manage security, sector, and country exposures, relying on our firm’s fundamental research platform and our own research.
But our bread and butter remain funds of funds. We focus on strategic and tactical asset allocation across major asset classes. This is going to sound self-promotional, and maybe a little out of tune for this newsletter, but we do these things really, really well. Please look at our track records.2
Our Asset Allocation Committee (AAC) oversees tactical asset allocation for our flagship portfolios. When we debate tactical positions, we tend to use asset class pairs—for example, growth versus value, large-caps versus small-caps, or high yield versus investment-grade bonds.
The AAC recently examined the “bones” under our tactical asset allocation positioning. I’m defining the bones here as the sector weights that underlie our positioning.
This year, sector dispersion has been extreme. As an example, the information technology sector is up 38.1%, while utilities are down -9.4%.3 Year to date through June, sector dispersion reached its 96th percentile on a rolling six-month basis—in other words, only 4% of all rolling six month periods since June of 1995 show wider sector dispersion.? In equity markets this year, sectors matter.
We ran a sector “X-ray machine” on our equity exposure. Leading the effort were quantitative Investment Analyst Cesare Buiatti, Portfolio Managers (PMs) and Cochairs of the AAC Charles Shriver and David Eiswert, and Associate Director of Research Rob Panariello.
Below is a table that shows sector exposures for seven tactical asset allocation pair trades.? Looking at the first number in the upper left, for example, U.S. large-caps (as represented by the Russell 1000 Index) have an allocation to energy stocks that is 3.1% lower than that of U.S. small-caps (as represented by the Russell 2000 Index).
It’s a lot of numbers. If you’re not into that kind of detail, I’ve added another table with rules of thumb.
It won’t come as any surprise that the X-ray revealed the importance of the technology sector in U.S. large-cap stocks. This sector has driven a significant part of the performance of large-caps versus small-caps, growth versus value, and international versus U.S. equities.
Conversely, value-oriented financials have driven most of the performance of European large-caps, where tech is a much smaller part of the market. The painful European value trap of the past decade or so has largely reflected the poor performance of European financials following the continent’s debt crisis in 2009-2010.
There were times in the past when, like many others, we underestimated the extent to which our weightings in international versus domestic stocks were really a bet on financials versus tech. At times, our AAC has overweighted international stocks based on valuation and contrarian macro considerations. While we were aware of it, we under-estimated the importance of this sector difference.
It gets a little more complicated when considering tech’s influence on the asset allocation trade-off between large-caps and small-caps. I’m oversimplifying, but in the U.S., if you bet on large-cap stocks versus small-caps, you’re betting on tech. Outside the U.S., particularly in Europe, you’re betting on financials—and you’re marginally short on tech.
Finally, another underappreciated—and probably surprising to many—element of the sector bone structure is that emerging markets stocks are now more exposed to tech than their developed market counterparts (as represented by the MSCI EAFE). Think of Chinese giants such as Alibaba, Huawei, and Tencent. A bet on EM used to be a bet on commodities. Now, it’s much more, albeit not entirely, a bet on tech.
So, why don’t we just make our allocation decisions based on sector allocations? First, like many of our clients, our mandate in our traditional funds of funds is to allocate across broad asset classes. Also, we work with people whom we trust to do that—the portfolio managers who run our underlying equity portfolios. They’ll generally make sector allocation decisions starting from the ground up—does this or that valuation make sense for this or that company, and are the fundamentals attractive?
The AAC focuses on relative valuations at the asset class level. Yes, we’ll look at macro, fundamental, and sentiment factors, but valuation is our number one consideration. We like to lean against the wind by overweighting asset classes when they’re cheap and underweight them when they’re expensive.
How our combined efforts impact sector weightings
Here’s a recent example of how it all comes together: We’ve recently overweighted real asset equities (energy and natural resources, real estate, basic materials, equipment, utilities and infrastructure, and commodities) relative to core equities. This is giving us exposure to sectors that haven’t participated as much as large tech in this year’s rally. We’re also expressing a view that there could be an upside surprise to inflation.
Within these sectors, the stock pickers in the underlying portfolios may select companies based on a wide range of factors, such as the quality of their fundamentals. Hence, we’re allocating to inflation protective sectors at the top level, while under the hood, we’re getting access to companies with what we believe have better fundamentals than if we allocated to the index.
My view is that, yes, inflation is coming down. Consider this the base case. The July print showing 3.2% year-over-year headline inflation was encouraging, and so was the monthly print of 0.2%. But underlying the 3.2% number was a 12.5% decline in energy prices, which included a 20% drop in gasoline and a 27% drop in fuel oil. I question whether we’ll see similar drops looking forward. Most commodities are trending in the other direction. A one-month decline in used car prices of 1.3% also kept inflation cool in July, but that’s a volatile data point.
领英推荐
From MRB Partners:?
Much of inflation’s ongoing descent relates to the unwinding of idiosyncratic post-pandemic distortions. There has been no meaningful downshift in the underlying trend of inflation that is driven by economic activity. The current consensus complacency on inflation implies a mounting risk of a rude inflation shock to bond investors and policymakers in the medium term.
Perhaps housing disinflation will offset higher commodities prices and the fading of favorable COVID distortions—in fact, some housing disinflation is baked in the cake due to lagged effects. Still, housing and rents are showing unexpected resilience in the face of high mortgage rates.
Our inflation concerns and our move into real assets are good examples of how our top-down and bottom-up views inform our asset allocation. More than usual, this process requires a deep understanding of the sector bone structure of asset classes.
REFERENCES
1 As of 7/31/2023, preliminary. Subject to revision.
3 As of 8/14/2023. Based on S&P 1500 sectors. Excluding Real Estate due to sector definition changes. Source: FactSet; data analysis by T. Rowe Price.
? Based on S&P 1500 sectors. Dispersion is defined as the cross-sectional standard deviation of sector returns. Excluding real estate due to sector definition changes. Source: FactSet; data analysis by T.?Rowe Price.
? A caveat is in order. Sectors differ across asset classes. “Duh,” my 15-year-old son would say (if he cared about finance). U.S. large-cap tech stocks, with their legendary cash flow-generating power, are different from speculative small-cap tech stocks. We use risk factor models to control for these differences, but that’s beyond the scope of this discussion.
? Excerpt from MRB Partners used with permission.
Please see Vendor Indices Disclaimers https://www.troweprice.com/institutional/us/en/site-content/disclaimers/vendor-indices-disclaimers/us-mutual-fund-vendor-indices-disclaimers.html for more information about the sourcing information.
IMPORTANT INFORMATION
The views contained herein are those of the author as of August 2023 and are subject to change without notice; these views may differ from those of other T. Rowe Price companies and/or associates.
This information is for informational purposes only and is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types; advice of any kind; or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not consider the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy. There is no guarantee that any forecasts made will come to pass. The charts are shown for illustrative purposes only. Certain assumptions have been made for modeling purposes, and this material is not intended to predict future events.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Stock prices can fall because of weakness in the broad market, a particular industry, or specific holdings. Bonds may decline in response to rising interest rates, a credit rating downgrade or failure of the issue to make timely payments of interest or principal. Technology stocks, historically, have experienced unusually large price swings, both up and down. The stocks face special risks, such as their products or services not proving commercially successful or becoming obsolete quickly. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. Commodities are subject to increased risks such as higher price volatility, geopolitical and other risks. Diversification cannot assure a profit or protect against loss in a declining market.
Index performance is for illustrative purposes only and is not indicative of any specific investment. Investors cannot invest directly in an index. Actual investment results may differ materially.?
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1 年Thanks Sébastien Page The US Strategic Petroleum Reserve in July ended at 354.366 thousand barrels around 50% lower than the average of the last 15 years. Therefore, this level is getting a geopolitical risk. However, the WTI price in the near future probability will be higher for longer. WTI Crude Oil Edges Higher as the First Major Storm of the Hurricane Season Moves Through the Gulf of Mexico. ??Hurricanes and tropical storms, including Hilary, have coincided with El Ni?o. There is a perfect positive correlation between #WTI #oil and the Underlying Inflation Gauge. WTI in June was at $70,25 near to the average for the period 2010-2020 which was $69,43. Nevertheless, if it would increase $20 to around $90, it might cause an increase in inflation of at least 0,8% pushing the inflation around 4% for 4Q23. Sticky demand-driven contribution and a possible rebound in the supply side due to a higher cost of commodities, meanly in energy factors. https://www.dhirubhai.net/feed/update/urn:li:activity:7103079673445699584?commentUrn=urn%3Ali%3Acomment%3A%28activity%3A7103079673445699584%2C7103109035410763776%29&dashCommentUrn=urn%3Ali%3Afsd_comment%3A%287103109035410763776%2Curn%3Ali%3Aactivity%3A7103079673445699584%29