* Home Comforts Sector Pair
We have been underweight the Domestic Defensives of Utilities & Telecoms since H214. Even in a trickier overall market we continue to expect cyclicals (especially value cyclicals) to outperform. But what of the positioning within defensives? We compare and contrast the 2 sectors in this report.
* Interest rate sensitivity
The interest rate cycle is the dominant current dynamic for equity markets in our view. Telecoms come with greater technology risk, reducing mid-term visibility. However this also means they are less sensitive to discount rates than other defensives, including Utilities. With a clear directional risk to rates (even allowing for soft US data) over the coming months this may prove to be critical.
* Leverage to macro recovery
Anaemic maybe, but a recovery nonetheless. Whereas Utilities’ macro-sensitivity has waned in recent years with energy efficiency a notable drag, there is a possible converse scenario for Telcos. Our team believe that the take-up of 4G service, superfast broadband, and pay-TV should all benefit from positive disposable income trends. Evidence of cyclicality gives room for optimism.
* Positive signs of structural change in Telcos
A consolidating oligopoly is usually a good place to be. After 15 years of deflation, there are some signs of stabilisation in ARPU and regulatory pressure is easing. As with macro-sensitivity, pricing power appears to be moving in the right direction, a conclusion much harder to reach for Utilities.
* Conclusion – Domestic Divergence
We conclude with a clear preference for Telcos over Utilities. Telcos have performed well this year, matching the market’s gains. With the best attributes within defensives we see this continuing and upgrade to Neutral. We accordingly downgrade the highly rate-sensitive sector Personal & Household to Underperform. Our tactically cautious but pro-cyclical view on the market is unchanged.