With stocks shrugging off the wall of worry in the first quarter, the second quarter could prove to be a less rewarding time for those long equity markets as central banks begin to tighten policy via rate hikes or withdrawing extraordinary measures.
Oil prices remain high on the back of the war in Libya and fears over contagion in the gulf, while Japan’s economy remains a worry.
But one asset manager believes there is value to be had in three sectors that are generating large amounts of cash and benefiting from so-called mega trends.
“We expect a rotation from the early cyclical sectors into the late-economic-cycle sectors," Ana Armstrong, the head of portfolio strategy at Armstrong Investment Managers, said in an interview with CNBC on Monday.
"With bonds yielding less than inflation we also expect investors will be attracted to equities in defensive sectors with much higher yields,” Armstrong added.
“We believe large-cap defensive stocks which have lagged cyclical growth now represent good value, while some cyclical sectors are now expensive,” she said.
Armstrong said some cash rich firms have been able to “carry out capital structure arbitrage, whereby they can issue debt in order to return cash to shareholders in the form of share buybacks.”
Three Sectors to Watch
Armstrong is a fan of the European healthcare sector which has not taken part in the stock rally of the last year.
“They trade at a 25 percent discount to the broader index based on forecast 2011 earnings and they are also trading at depressed levels on book value and cash flow,” she said.
“Their lowly rating reflects concerns about future revenues after the so-called ‘patent cliff’, which sees many companies lose exclusivity on their blockbuster drugs, as well as US healthcare reforms and European austerity measures,” Armstrong added.
Drug majors are highly cash generative and set to benefit from positive demographic trends like ageing populations, she explained.
“Despite committing billions of dollars to research and development over the coming years, we believe the markets has drug pipelines priced at zero in terms of economic success,” Armstrong said.
She also likes telecom stocks due to strong dividend yields and the prospect of dividend growth which rises above inflation.
“Telefonica for example is trading 17.5 euros a share, has an historic yield of 8 percent and announced it will be increasing its dividend to 1.75 euros a share,” Armstrong added.
Armstrong is also a buyer of European luxury goods stocks due to strong demand from Asia. “Demand for high-end European brand names is exceptionally strong in Asia and these stocks have sold off significantly based on exposure to the Japanese consumer,” she said.
“We expect the Asian consumer and Emerging Market consumer will continue to be fuelled by the very loose monetary policy in the West and companies involved in high-end branded luxury goods will continue to exhibit tremendous growth despite a potential slow down in Japan,” Armstrong added.