Recap 8-13-12

Main Items:

  • Mitt Romney picked Paul Ryan as his running mate.

Overseas:

  • Japan Nominal GDP declined -0.1% QoQ in 2Q vs +0.4% exp and 1.2% prev

Upcoming Data:

  • Mon: RICS House Prices Balance, BoJ Minutes, Australia NAB Business Confidence
  • Tues: UK CPI, EU 2Q GDP, German Zew, US PPI, Retail Sales
  • Wed: MoE Minutes, UK Employment, US CPI, Empire Mfg, NAHB Index
  • Thurs: EU CPI, US Jobless Claims, Housing Starts
  • Fri: Canada CPI, U Michigan Confidence

Commentary & Links:

The Vix index settled at the lowest level since 2007 today. However, historically, new 1y lows in the Vix over the past two years have preceded further quiet rallies over the short term:

Also, note that recent equity market performance has been driven by defensive stocks. Utilities and Staples are both very rich on a valuation basis versus the broader index. The chart below shows a scatter plot of the S&P sectors’ beta (as a proxy for defensiveness) and the distance from the 52 week high. As the chart shows, the broader index has essentially been dragged higher by low beta, defensive sectors, while the pro-cyclical sectors have lagged sharply.

There are several possible explanations for this. While there certainly have been inflows into the equity market, it’s not clear how much of the flows into defensive sectors came from new money, cyclical sectors, or fixed income. It’s probable that all three were contributors, but the most important may be the switch from fixed income. If that persists as a driver, the current valuation differentials could widen as investors increasingly perceive defensive sectors as a long duration bond. To some extent, this has been supported by flows data.

Given the sizable valuation differentials, buying cyclical sectors versus the broader market appears to be good risk vs reward. (Industrial and Technology names in particular appears cheap) However, if the fixed income to equity asset allocation shift was the main driver of defensives outperformance, such a bet may not work as well.

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