On Friday, the US Labour Department released the Non-Farm payrolls for August. 151,000 jobs were added to the US economy in August and the unemployment rate rose slightly to 4.9%. Expectations were for an increase of 180,000 jobs following a revised 275,000 jobs added in July.
High PE ratios
The markets took the miss as a cue to dump the dollar and buy equities. Friday afternoon’s move represents a school of thought that the Federal Reserve would not hike rates prematurely and further support equities for the foreseeable future.
Notable FTSE 100 outperformers in the wake of the slight miss in expectations were defensive low growth pharmaceutical and consumer goods companies. As these stocks rallied, there price-to-earnings ratio were further expanded to historically rich levels.
Banks and house builders rally
This was a week where UK facing shares did most of the heavy lifting in the FTSE 100. Banks and house builders rallied throughout the week as a consequence of better than expected UK economic data.
The improvement in the UK economy caught the bears off guard and drove a short squeeze in heavily shorted stocks.
As these cyclical sectors rallied, traditional defensive stocks sold off – that was up until 1.30pm on Friday when fears of a hawkish Fed were forgotten.
I would take the divergence in performance in cyclical and defensive sectors last week as sign of things to come.
Investors have been clearly shunning overvalued defensive shares and allocating to those recently unloved ‘value’ cyclical shares.
Value trap
The rally in UK cyclicals last week does have an essence of ‘value trap’ to them and it is likely that it begins to lose steam soon. Those chasing the upswing in cyclical may be disappointed but there is still a valuable lesson to learn from last week.
The critical observation is what happens overvalued and low-growth defensive stocks when the Federal Reserve shapes up for a hike.
Bond proxy unwind
Investors have been forced into stocks with stable cash flows and reasonable dividend yields known as ‘bond-proxies’. With benchmark bond yield at record lows, income seekers have little choice and are buying with little concern for valuation metrics.
We could argue this is at the core of distortions in equity valuations. Such distortions appears as blip over a long enough timeline and last week is evidence we are close the peak of this blip.