D A N T E S O U T L O O K
Markets have priced in a sharp but likely short-lived global recession, and the recovery from March lows suggests bulls are preparing for an economic upturn. We prefer to overweight cyclical assets such as industrial metals, energy, and consumer discretionary, which tend to outperform the broader market after significant sell-offs. The copper/gold ratio supports this view, which is recovering from deeply oversold levels this year, similar to previous market bottoms.
Further, the US dollar (USD) is selling off, which should be a positive for the S&P 500 (shown in the bottom chart panels). The monthly chart on the left shows that USD typically struggles below the 100 level, especially over the past decade, while the S&P 500 has maintained long-term support. And the shorter-term weekly chart on the right shows USD beginning its descent right as the S&P 500 rebounded off March lows. A lower USD will support the economic recovery and provide a tailwind for commodities.
The CRB Raw Industrials index is finally at support, coming off a decade-long downtrend in which it failed to recover from 2008 lows (left chart). On the flip side, the S&P 500 has sustained a strong uptrend since 2008. Given this divergence between commodities and equities, investors will likely seek value opportunities particularly in the energy sector ETF (XLE), which has been out of favor relative to the technology ETF (XLK) as seen in the lower panel on the right. While we don't expect a massive rotation out of tech to energy, we recognize that relative upside for existing market leaders is limited given the extreme price divergence that has persisted for far too long.
Regarding asset allocation, even as risk-appetite returns, we maintain our view that less volatile assets such as sovereign bonds play an important role in mitigating downside risk. And for more specialized absolute return portfolios, we'll examine how to position between industrial and precious metals (risk-on vs. risk-off) over the long-term in our next post.