Chief Investment Strategist
Summary: Volatility is on the rise today with European banks headed lower as interbank funding stress remains elevated. There is a risk that this could snowball into a wider crisis and thus investors should think about their exposure across industry groups, segments, and themes. We map out which pockets of the equity market provide relative safety for investors and what should segments of the equity market should be reduced.
Defence, semiconductors, and mega caps are holding up
It has been a dramatic week as we have highlighted in our recent equity notes with the risk that these events will snowball into a crisis moment for the financial and monetary system. Yesterday, the rebound flows came in hunting for quick gains following a dramatic Monday trading session across all asset classes, but today things are reversing fast with the FRA-OIS 3-month spread (interbank funding spread) increasing to ~65 basis points which is the highest since the low point during the early days of the pandemic. European banks are offered heavily in European trading with the leading European banking index down 6.8% and EURJPY (a proxy for risk-off flows) down 3% which is a big move. Investors should be prepared for further increases in volatility across not only equities but all asset classes. In today’s equity update we aim to map out where flows are headed across different segments of the equity market.
STOXX 600 Banks Index
Across our theme baskets investors are still bidding up the values of themes such as semiconductors, and defence. Mega caps are also holding up relatively well as the biggest companies in the world are seen as a relative safe haven. Themes reflecting discretionary consumption such as travel and e-commerce are under pressure, and high duration stocks such as our bubble stocks basket is the worst performer the past week down 7%. For the long-term investor our main view on themes is still that the physical world will outperform the digital world as a function of high structural inflation, higher interest rates, fragmentation of global supply chains, green transformation, and the war in Ukraine.
What should investors consider?
As we wrote yesterday small caps are always a bigger risk when financial conditions are tightening so investors should consider reducing exposure to small caps. Financials should naturally also be reduced as the unknown risks at this point are high. Quality companies with low debt levels, high return on invested capital and market leading positions should be increased. Examples of ETFs providing exposure to different variations of quality are FCF US Quality ETF, VanEck Morningstar Wide Moat, and iShares Edge MSCI World Quality Factor UCITS ETF.
The top 10 holdings in the FCF US Quality ETF (these are stocks should not be viewed as investment recommendations but a reflection of one interpretation of quality)
Looking across global industry groups we see the classic investor flows and behaviour with defensive industry groups such as Household & Personal Products, Utilities, Pharmaceuticals, Food, Beverage & Tobacco, and Commercial & Professional Services being relative stronger. The weakest segments of the market are Banks, Diversified Financials, Insurance, Energy, Real Estate, and Automobiles & Components. The list of stocks below are based on selecting the three largest companies from each of the best performing industry groups mentioned above.
Finally, for those equity investors that simply wants to reduce overall risk short-term bonds should be considered.
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