Two Sell-Side Views on the Market

This is the 5th year of a bull market. Unless DC really flubs it, the “Raging Bulls” on the sell-side call for a new secular bull market in 2013 that takes out old highs on the S&P 500. Multiple expansions across sectors are needed to hit this target.

Just behind the “Raging Bulls” are the “Analytical Bulls.”

With the global economy strengthening, and above-trend U.S. GDP growth forecast for 2014, the Analytic Bulls on the sell-side favor a cyclical sector allocation. A relative value trade against credit looks generally good for stocks now. Sentiment is strong early.

Some on the sell-side think the market will be strong out of the gate, but then run out of catalysts by mid-year. Deep cyclicals are the bet. Buy the dips in the first half of year. Clarity from a cliff deal could show up in larger trade sizes.

Concerns about a peak in corporate profit margins and U.S. fiscal policy risk keeps sector weights short of outright cyclical for some.

Global risks to this cyclical sector bias stems mainly from a weaker growth outlook in Europe and China. Any disappointment in those regions may restrain risk taking and create downside to earnings and sales of more exposed sectors. Similarly, if U.S. GDP and payroll growth softens, investor preference for yield and safety may persist as a headwind.

Bullish Sell-Side Sector Calls in 2013

The Materials sector is the big sell-side flavor this year. Analytic Bulls on the sell-side see a mean reversion trade; China strengthens; Europe is stable; housing up in U.S.; high growth exposure; low expectations; a 2.4% dividend yield makes the sell-side particularly positive.

Or participate in the likely grind higher over the next few months with over-weights in Info Tech and Industrials. Remain overweight in Financials on another expected leg up later in 2013.

In sum, overweight the cyclical sectors with lowered expectations.

Bullish Sell-Side Consensus for 2013

Overweight: Info Tech, Industrials, Materials and Financials

Neutral: Consumer Discretionary, Health Care and Energy

Underweight: Consumer Staples, Utilities and Telecom

What is the sell-side bull argument to an underweight rating on defensives?

They are expensive. Each sector has benefitted from event-driven uncertainty and investors’ preference for yield. Accordingly, the sectors carry higher valuations. Valuation differences across sectors are likely to moderate in a better growth and policy environment.

What is the primary bull risk seen to an underweight allocation on defensives?

Yield. Only Telcos (4.8%) and Utilities (4.3%) sectors offer dividend yields above 4%. Consumer Staples is the third highest at 3.0%.

What is the sell-side bear’s strongest argument for defensives in 2013?

Leading economic indicators and earnings vulnerabilities continue to suggest a more cautious tone is necessary. The best opportunities in the S&P 500 are defensive sectors, where earnings revision momentum is more stable and yield is increasingly attractive relative to other asset classes.

Yield scarcity is driven by the combination of increasing demand from an aging population and limited supply thanks to monetary policy. Thus, the premium for yield is not likely to fade until interest rates move materially higher, offering an aging demographic other opportunities for investment. Several segments within the S&P 500 now have higher dividend yield than comparable bond yields.

Bearish sell-side overweight recommendations remain Health Care, Consumer Staples and Utilities.