The Street’s Fav Sectors, Gold, Inflation

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The Street’s Fav Sectors, Gold, Inflation

Three Data items today:

#1: Let’s start by circling back to the FactSet Earnings Insight report we highlighted last night for its take of which sectors Wall Street analysts think have the greatest upside right now. FactSet does this by aggregating average price targets by individual names and then bubbling that up to the sector level.

Here is the FactSet chart. Energy, Health Care, Tech and Consumer Discretionary all have aggregate price targets higher than the S&P 500’s 9.8% theoretical upside. Communication Services, Consumer Staples, Materials, Utilities, Financials, Real Estate and Industrials have lower aggregate price targets than the market as a whole.

Two thoughts:

First, the cynical approach would be to do the opposite of whatever Wall Street analysts recommend since they represent the consensus view. There’s actually some sense to this approach. The stocks analysts dislike the most often see dramatic upside when the Street starts to turn more favorable on them and, of course, vice versa.

We do like Industrials here and the fact that this group has the lowest Wall Street price target upside of any S&P sector is notable. Also, Industrials as a group have the highest ratio of “Sell” ratings (9 percent) of any S&P group besides Consumer Staples (11 pct).

Second, if one is of a less cynical mind, then Energy, Health Care and Tech are the places to look for outperformance. Not only do they have the loftiest price targets, but they have the highest percentage of “Buy” recommendations in the S&P 500 (61-62 percent vs 56 pct for the index as a whole).

Our order of preference is Energy, Tech and Health Care because our overarching investment theme continues to be cyclical recovery.

Takeaway: while we’d never lean too hard on Street buy-sell-hold recommendations when making investment decisions, they are worth a look if only so you know whether you’re with the consensus or against it.

#2: While we’re always saying a diversified portfolio can include a small (3-5 percent) allocation to gold, the yellow metal certainly isn’t carrying its weight in 2021 (down 8.6 percent) so let’s examine why.

We routinely discuss with you the World Gold Council’s analysis of global fund flows on a month-by-month basis, and the $8 bn of redemptions from US precious metals funds in February/March explain much of the decline in gold prices. Recall that the last 2 months have been among the best in a decade for equity fund inflows, so that tells us where the capital redeemed out of gold funds has most likely gone.

This 2007 – present WGC chart of global gold fund flows (the bars) versus gold prices (the line) is a bit of an eye-strainer but it shows just how much impact US fund flows (in purple) have over time. When the US funds see outflows, gold prices decline (2012, for example). When they see inflows, gold prices rise (2008 – 2011, 2015, 2020). There is a link to the WGC page below if you want to access the underlying data.

Takeaway: US investors have been swapping out of gold and into stocks, but this trade can work the other way if inflation becomes more of an issue later in the year. That would drive yields higher, crimping equity valuations and reigniting interest in gold as a hedge.

#3: An update on 5- and 10-year Treasury Inflation Protect Securities (TIPS) implied inflation levels. This is the annual inflation baked into TIPS prices, one market-based estimate of future price increases. Here is the data for 5-year (blue line) and 10-year (red line) expected inflation back to 2010.

Two things worth noting about this chart:

First, notice that 5-year expected inflation (blue line, far right) now hovers at decade-plus highs, but 10-year expected inflation (red line, far right) does not. The latter was materially higher, for example, in 2011 – 2012 (left side of the graph).

Second, expected 5-year inflation is well above expected 10-year inflation (blue line over red line) and that is very unusual. Typically, expected longer-run inflation is higher than over the shorter term. Put another way, the TIPS market is saying that the second half of the next decade should see quite a bit less inflation than the next 60 months.

Takeaway: the TIPS market is showing less conviction that inflation is a long run (10 years) problem than over the shorter run (5 years). While nominal 10-year yields remain strangely below expected inflation at 1.67 pct versus 2.33 pct, this does at least partially explain why benchmark US yields remain so relatively low and stable. Markets are quite sure inflation will pick up temporarily but are much less convinced this is sustainable.

Sources:

FactSet Report: https://www.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_040921.pdf

World Gold Council fund flow data: https://www.gold.org/goldhub/data/global-gold-backed-etf-holdings-and-flows/2021/march