The recent ISM manufacturing figure for May showed weakness, causing a short-term setback for the reflation narrative. However, there are numerous signs from both the market and forward-looking indicators suggesting we could be in for a substantial boom in manufacturing. As Oskar Vårdal from Steno Research notes, "We could be in for a VERY hot summer/autumn in manufacturing terms." This article will explore the actionable investment strategies presented in the original article.
Cyclicals vs. Defensives: A Strategic Shift
Market pricing in cyclicals versus defensives still shows support for materially higher ISM manufacturing levels around 56-57. Vårdal points out, "It might seem surprising to discuss the ISM reaching 56, but there are intriguing signs from high-beta economies like Sweden, Germany, Canada, and South Korea." The IFO index suggests a brighter future for the most cyclical components of the German economy, while Sweden’s orders-to-inventory ratio for manufacturers has surged recently, driven partly by rate cuts.
Investors should consider shifting their portfolios towards cyclical sectors. Materials, Consumer Discretionary, Industrials, and Consumer Services are currently traded at a discount in the scenario of rising ISM manufacturing levels. Vårdal highlights, "Materials have already had a great run on the first manufacturing rebound story, but there could very well be more return to pick up if manufacturing activity arrives in style in summer/Q3."
Energy and Utilities: Evaluating Fair Price
While cyclicals are recommended, defensives like Energy and Utilities are above their fair ISM price. However, Vårdal suggests, "Throwing a bit of inflation over the summer into the mix, the Energy bet might not be that expensive." Investors should weigh the potential benefits of holding energy stocks if inflation increases.
Global Equity Markets: Look Beyond the US
Korea and China remain the cheapest equity indices relative to the US business cycle. Vårdal observes, "The issue for Asian equities has been the latent risk of a debasement of the local currency when/if the USD rates remain high(er) for longer." For more on Chinese industrial production, read the analysis on Chinese inflation export here. Nonetheless, German and Swedish equities also remain attractively priced, aligning with early signs of growth in their manufacturing sectors.
Forex Strategies: Betting on the Undervalued
In the Forex market, SEK and AUD are relatively cheap compared to the US business cycle, while EURUSD and GBPUSD could gain materially if ISM manufacturing booms. Vårdal notes, "The Swedish survey data hints of a significant ongoing boom in Sweden," which supports the strength of the SEK. Conversely, NOK is severely underpriced and could perform well if oil prices rise and US manufacturing rebounds further. See the lastest FX Daily update right here:
Commodities: Focus on the Fundamentals
If ISM manufacturing truly rockets, commodities, rather than commodity stocks, are the place to be. Vårdal emphasizes, "Both Crude and Natural Gas have become fairly cheap relative to the potential boom in the manufacturing sector, joined by Palladium." Palladium, primarily used for catalytic converters in cars, indicates that car production has not been as strong as broader economic data might suggest.
However, Vårdal advises caution with Silver and Gold, noting, "Silver is still overvalued, even if ISM manufacturing rises to 56." Energy commodities are generally seen as cheaper and more promising than metals in the context of a manufacturing boom.