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Upside risks

Published on 11-05-2020

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Short-term shakeouts as buying opportunities


Since the dark days of March and April, I have remained steadfast in looking across the valley to better times ahead, and this time is no exception. Regardless of near-term turbulence, I continue to favour portfolio positioning for optimistic, long-term outcomes by emphasizing the “recovery” trade and embracing cyclicality. Fortunately, key barometers of global growth have validated this positive outlook.

Each month, the JPMorgan Global Manufacturing Purchasing Managers Index (PMI) takes the first pulse of business conditions and executive sentiment across the worldwide manufacturing sector. Not only has the PMI enjoyed a literal V-shaped recovery, but it has achieved levels of optimism higher than those immediately preceding the Great Lockdown (Figure 1).

Similarly, South Korea is the first major exporting nation to release monthly trade data, providing an early gauge of international commerce. Improving planetary demand for chips, computers and cars are supporting shipments from this high-tech, industrialized and global growth-sensitive economy. Indeed, South Korean exports are growing faster now than they were before the pandemic (Figure 1).

In North America, U.S. retail sales have rebounded to a high single-digit pace unseen since the aftermath of the Great Recession and Global Financial Crisis of 2008-2009. Clearly, fading government support, delays over further stimulus payments, and still over 700,000 people filing for initial jobless claims each week haven’t stopped American consumers from spending.

Downside risks

Have my views changed given the recent risk-off tone in markets? No. But responsible stewards of capital must contemplate the downside risks. In order to derail the cyclical advance, I believe something devastating would have to happen.

True, the rise of new COVID-19 cases has been weighing on risk assets, including the overall stock market. In response to increasing infection rates, Germany, France, and Canada have renewed lockdowns and social restrictions to curb the spread of the coronavirus.

Despite virus-related concerns, however, S&P 500 industries that previously profited from the shutdown (i.e., biotechnology, hypermarket & super center, interactive home entertainment, internet and direct marketing retail, and internet service and infrastructure stocks) have been underperforming those that stand to gain from reopening (i.e., airline, casino & gaming, hotel, resort and cruiseline, and restaurant stocks) since early July. In other words, when the dark blue area declines, it means the “reopening” beneficiaries outperformed the “shutdown” beneficiaries (Figure 2).

Perhaps these leading indicators of potential economic activity are sensing another peak in the case count, as they did back in June/July and February/March? If so, I would prefer to take a cue from such intra-stock market trends and stick to the broader “recovery” trade.

Upside risks

Is it possible that investors spend too much time worrying about the downside risks and not enough time considering the upside risks? For this exercise, let’s explore some “what if” scenarios:

As a result, I’m inclined to interpret the recent shakeout as a temporary risk-shedding event, as opposed to a sinister change of trend, and I continue to treat such short-term pullbacks as buying opportunities for stocks. In fact, this technical indicator suggests S&P 500 industry breadth or participation has essentially fallen to washout levels (Figure 4), and a playable rally may ensue.

Stick to cyclical growth

Within the economy-sensitive sectors of the stock market, the real debate still centers on “growth” cyclicals (e.g., information technology, consumer discretionary) versus “deep value” cyclicals (e.g., financials, energy).

I’m watching the yield curve or spread between 10- and 2-year government bond yields for signs of a persistent rotation into deep value cyclicals. True, the yield curve has steepened a bit recently, but has failed to break out above 0.7% so far in the economic recovery.2

From my lens, financial and technology stocks seem unconvinced the economy’s about to rapidly shift into sustainably higher gears. Until it does, I’m staying committed to cyclical growth. (No, the bottom of the chart doesn’t equal technical support.)

For price-conscious investors, it might be more palatable – and maybe just as effective – to consider participating in this prolonged, low-altitude recovery and cyclical advance through the industrial and material sectors.


1. Source: CNBC, 10/22/20.
2. Source: FRED, 10/28/20.


Talley Léger is Senior Investment Strategist, Invesco Thought Leadership, Invesco Canada.

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© 2020 by Invesco Canada Ltd. Reprinted with permission.

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