Unsophisticated investors tend to focus on benchmark equity market indices such as the Eurostoxx 50 Index and Stoxx 600 Index; to understand equity returns. Whilst this is an effective measure to understand overall equity market performance, there is greater detail to be captured through analysing industry performance that will shed light on current market expectations, as well as, to determine industry risk premiums that have an impact on company-specific equity valuations.
The Global Industry Classification Standard (GICS) provides definitions for industries that aggregate into sectors. This gives investors a common scale on what constitutes an industry and a sector, thereby providing the basis for comparability and consistency throughout different global markets. Similarly, Stoxx limited (a Swiss-based company); provides indices at a sector level which can be used to measure sector performance.
These sectors are based on the Industry Classification Benchmark (ICB) which is another global industry and sector classifier similar to GICS, however, the definitions differ.
What is the story told by industry equity returns for the first three quarters of 2019?
The start of 2019 came off a difficult period as the fourth quarter of 2018 saw equity investors whipsawed as a result of market uncertainty that gyrated investor sentiment.
This risk-off environment reversed course at the dawn of 2019 as equities were in oversold territory both technically and fundamentally. Greater visibility on the US-China trade front as well as dovish global Central Banks set the tone for the period. Empirical evidence shows that cyclical and growth companies will be the investment of choice in a market environment that is upbeat about economic and business prospects.
In fundamental terms, (i.e. Revenue and Earnings growth) these companies will outperform non-cyclical and defensive companies.
Industry indices provide an insight into the markets' assessment of the industry’s prospects.
Rationally, the best performing industries provide better prospects going forward. In a way, an investor can extrapolate past data into the future to understand (market expected) industry outlook. Notwithstanding, investors should always thread with caution when interpreting past data, given the list of potential pitfalls.
At the beginning of the year till the end of the third quarter of 2019, investors could observe that the Food and Beverage industry was the outperformer compared to its peers with a total return of 32.86% (overall Stoxx 600 return stood at 20.74%).
The explanation for this outperformance was that despite the rise in equity markets, defensive industries still did well given the fact that the market believed that the outlook might be compromised by event risks.
In fact, during the period, US-China trade tensions remained in focus, a No-deal Brexit was still a possibility and European economic data continued to disappoint. Amongst the worst performing industries for the period were banks (with a total return of 5.90%) as the grim outlook for yields in Europe depressed earnings prospects for the industry.
How does new information change the fortunes of industry performance?
Recent market events give a striking example of how new market information impacts industry returns*. Specifically, optimism on US-China trade gained momentum, the No-deal Brexit scenario faded and the US toned down its hostility towards Europe on the tariffs front. Specifically, Autos and Parts became the best performing industry for the period with a return of 11.59%. This came on the back of news that the US will not be imposing tariffs on European autos and parts companies.
Conversely, the Food and Beverage (which was the best-performing industry for the first three quarters of 2019) industry experienced a significant drop in returns as the market rotated towards cyclical and growth companies. In conclusion, decomposing benchmark equity index returns through understanding sectorial and industry performance will provide investors with a greater insight into market expectations that will have a direct impact on the overall equity portfolio strategy.
*The period under review is from 30th September 2019 to 6th November 2019.
This article was issued by Jesmar Halliday, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.