Treasure Chest: Global Indicator Triggers Buy

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By Greg Peel

BA-Merrill Lynch’s in-house contrarian indicator, the Global Breadth Rule, has triggered a Buy signal for global equities, with 43 out of 45 equity markets now “oversold”, meaning they are trading below both their 200-day and 50-day moving averages.

The only time Merrills GBR has failed in recent years was in July 2008 after which equity markets went into meltdown. Otherwise a Buy signal is historically followed by 6-7% gains over 4-6 weeks. The last Buy trigger was in June last year, and equities subsequently rallied 30% to their highs.

The GBR is nevertheless a short-term rather than longer-term indicator, Merrills is quick to point out, with sustained equity rallies usually needing changes in policy to shift investor behaviour.

Merrills notes the two of the 45 markets not currently oversold are the US and Japan. The US has not pulled back substantially from its highs, and while Japan corrected 20% it was only after an 80% run-up. The markets that are most oversold are those related to China and to carry-trades. This would presumably includes Australia, although Merrills highlights Brazil, Turkey, South Africa and Mexico, implying Australia is oversold but not one of the “most” oversold.

Sector-wise, Materials is most oversold globally while Healthcare and Consumer Discretionary are the least.

Citi’s global strategists note last week’s global earnings upgrade to downgrade ratio was 2:3, consistent with the fall in markets. It was the worst week year to date in terms of more downgrades than upgrades. Citi suggests there is a level of uncertainty prevailing among analysts.

The US yield curve is steepening, and under normal circumstances this would trigger global earnings upgrades. But Citi feels analysts are not yet convinced about an improvement in the growth outlook.

No doubt one can put this uncertainty down to Fed tapering talk which, while steepening the yield curve as US longer bond yields rise, is yet to confirm expected US growth. So far Fed tapering talk is just that – talk – and few expect tapering to begin soon, and perhaps not at all this year. The yield curve is merely adjusting to the prospect of tapering, which must one day come, given historically low yields having been reached.

Despite recent volatility, Japan continues to see net earnings upgrades, Citi notes. Most of the downgrades have come from Europe and Emerging Markets, although the US is still seeing net downgrades. Pre-announcements ahead of the June quarter US earnings season have been weak to date.

Sector-wise, global Technology and Healthcare have seen net upgrades while Utilities, Materials, Energy, Consumer Staples and Consumer Discretionary saw the biggest net downgrades.

Macquarie’s Australian equity strategists suggest recent volatility has highlighted investor nervousness over whether or not the business cycle is indeed improving from its period of long, grinding lows to some weak level of sustainable growth. If a transition is indeed underway, bond yields will have seen their lows and the rotation out of yield stocks into growth will continue.

The path will unlikely be smooth nevertheless, Macquarie warns, given the uncertainty surrounding Fed policy.

Normally when the Aussie dollar falls the fall is reflective of weaker global growth expectations. However, this time the situation is different, Macquarie notes, as the world shifts out of the yield-based carry trade in expectation of global growth. The earnings outlook for globally-focused Australian stocks thus sees risks shift to the positive. This should imply a period of significant underperformance for “yield”.

On that basis, the Macquarie strategists remain Underweight banks, although prefer Commonwealth Bank ((CBA)) and ANZ Bank ((ANZ)) in the sector. The lower currency sees key positioning in global industrial cyclicals James Hardie ((JHX)), News Corp ((NWS)), Brambles ((BXB)), Amcor ((AMC)) and Computershare ((CPU)), as well as global REIT Goodman Group ((GMG)), and limited exposure to domestic cyclicals JB Hi-Fi ((JBH)), Toll Holdings ((TOL)), DuluxGroup ((DLX)) and Mirvac ((MGR)) on expectation of improved earnings forecasts in FY14.
 

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