Over at Credit Suisse, Andrew Garthwaite has been telling clients to reduce weightings of cyclical stocks because they are too expensive and a V-shaped recovery is not going to happen (emphasis ours):
Price/Book value of cyclicals relative to defensives is now nearly one st. dev. above its norm (13%), while the P/E relative to the market is even more extreme.
Cyclicals have historically outperformed defensives by 32%. So far, they have outperformed by 40%. Four out of the last 7 cyclical rallies have lasted less than 6 months—this one is 5 ½ months old.
We believe in an upward sloping W-shaped recovery. We are seeing an inventory rebound (IP has to rise 5% to normalise inventories), but we think growth will not return to trend for another couple of years, as we estimate there is still $7trn of excess leverage in the G4 (28% of GDP) and US household liabilities relative to assets have never been this extreme (we believe the US savings ratio needs to rise to 10% from 4.2% now). Additionally, in most of the world housing still looks expensive (though not in the US) and lending conditions are still too tight. Even into a ‘normal’ economic recovery (1991, 2002), the initial rise in ISM only lasted 7-8 months. Double dip concerns have been evident in most ‘normal’ economic recoveries.
Nick Nelson at UBS is not that bearish, but he reckons defensive stocks now offer better value and should outperform:
We would not reverse the move towards cyclicals and retrench in the defensives. We believe that there has been a sufficient change in policy, economic data and earnings momentum to suggest things have moved on since Q4 last year. But the recent rally has been indiscriminate in its pursuit of cyclicality and has also rewarded the stocks with the smallest market cap and highest financial leverage the most. This has provides an opportunity.
From here, we would expect the large cap, less geared stocks (cyclical or defensive) to perform better. We would also revisit the dividend yield theme. Many of these stocks have underperformed in the recent rally and the low level of risk-free rates still makes a case for higher and secure yield attractive.
Which brings us to Goldman. Sharon Bell has been looking how much short covering has contributed to the recent stock market rally and the answer is, a bit:
There is evidence that a short squeeze boosted performance in this recent rally. Using Euroclear stock lending data for UK and Ireland, we find that those companies in the top quartile are up 55% from the low, vs. around 30% for the other quartiles. This result holds even adjusting for the size and sector of stocks on loan.
But she notes the amount of stock on loan has fallen to a five-year low:
In addition, the amount on loan has fallen significantly suggesting many shorts have now been taken off. On average 2.9% of stock was borrowed in April a drop compared with recent months and a low vs. the last 5 years.
All of which means:
Any ‘push’ to equities from the short squeeze is likely to fade
While a short squeeze has influenced some names, we think the improved economic data has been the more important driver for the majority of stocks. But given the fall in stock lending, any additional ‘push’ from a short squeeze is likely to be less evident from here; momentum in the economic data will be even more crucial if the rally is to be sustained.