Taking a more defensive investment stance

With event risk increasing, Robeco’s Economic and Financial Markets Analysis team have shifted to a neutral stance on equities. Ronald Doeswijk, Senior Strategist, explains.

With event risk increasing, the room for positive earnings surprises becoming smaller and the time of year approaching that typically sees equities underperform, Robeco’s Economic and Financial Markets Analysis team have shifted to a more defensive investment stance. They have moved from being cautiously optimistic on equities to neutral.

This increased defensiveness has also impacted their regional and sector positioning. They now prefer the US to Europe (against a previously neutral position), and they have moved to a neutral view on emerging markets (which they previously favored). They no longer have a preference for cyclical sectors, either.
Event risk is key trigger for switch

What has triggered such a switch? First, increased event risk. Ronald Doeswijk, Senior Strategist with the team, points to rising yield spreads on bonds issued by Greece and Portugal. “The deficit and debt problems in Southern Europe have not been resolved in a structural way,” he says. “A possible downgrade of UK sovereign debt could further increase the uncertainty in financial markets.”

A second point is that the scope for unexpectedly strong macroeconomic or company earnings news is declining after a year of robust economic surprises. “It will become harder for both economic growth and company earnings to exceed consensus estimates,” notes Doeswijk.

Third, the period of the year that historically has resulted in low risk premia is approaching. “We believe there is truth in the adage “Sell in May”, which implies that equities perform better during the period November through April than from May through October,” says Doeswijk.

Equity rebound likely to fizzle out
In more general terms, after a 74% rally by equities (in euro terms) from the March 2009 bottom and a drop in the VIX index to around 15 (see chart), the Economic & Financial Markets Analysis team believe it is becoming more likely that the strong rebound in equity prices will flatten out. “We prefer to take a wait-and-see approach regarding the tackling of Southern Europe’s debt problems,” says Doeswijk.

Reflecting these developments, the team have made a number of shifts in their view on financial markets. Most importantly, they have switched their positive view on equities to neutral. They have also made changes in their regional and sector views. On a regional basis, they now prefer North America to Europe. “Renewed debt fears will initially center in Southern Europe and the UK,” explains Doeswijk. “Thereby, the US dollar’s rally might have further to run.”

Emerging markets no longer favored
As part of the more defensive stance, the team no longer prefer emerging markets to the Pacific region: they are now neutral on both regions. Doeswijk notes that the relative performance of emerging markets has been roughly flat for over six months now.

The defensive stance has also resulted in shifts on the sector front. The team no longer prefer cyclical sectors to defensive ones. “Momentum is still very strong in most cyclical sectors, while defensive sectors have been lagging the market for more than a year. But this pattern might change now that economic surprises are becoming less likely,” says Doeswijk. In addition, sectors have shown a clear seasonal pattern in the past, parallel to the general stock market.

As a result, the team no longer favor energy and materials, and they are now neutral on both sectors. They have also softened their strongly negative view on telecom and utilities, though they are still slightly negative on these sectors. They have a similar take on financials. But the team remain positive on industrials and IT.