Thursday, October 1, 2015

Trans-Atlantic opportunities in Energy and Healthcare

Sometimes it can be useful to step back from focusing on the specifics of a single market to think about the relative performance of sectors globally and how macro conditions affect each region. In a lot of cases, the relative performance of American and European sectors to their markets track each other closely and their divergence can yield insights about either opportunity or macro differences between economic blocs.

For example, here is a chart of the relative performance of financial stocks on both sides of the Atlantic. They are highly correlated and there are no special insights to be gained here.

An opportunity in European Energy
By contrast, a relative performance gap has opened up between US and European Energy stocks. European energy stocks have far underperformed US energy on a relative basis and they are sitting near all-time relative performance lows stretching back 18 years.

On a cap weighted basis, the characteristics of the European and US sectors are fairly similar. The European Energy sector is dominated by mostly megacap integrated companies, e.g. Royal Dutch, Total, etc., while smaller names include the likes of ENI and Repsol - all of which are well diversified integrateds. By contrast, the US has far higher higher beta exploration and oil service companies in its energy universe.

As oil prices have cratered, it makes no sense that European large cap integrated oils should underperform more than American ones, especially when you consider that the price of Brent has performed better in euros than USD.

This pricing gap suggests a couple of opportunistic trades:

  1. Buy European large cap energy and short US large cap integrated energy
  2. Buy a long Europe Energy/European market pair, while short US Energy/US market pair
Unfortunately, there are no US listed ETFs that American investors can readily get easy exposure to European energy stocks. The alternatives are either a European listed ETF (example here), or create a custom basket of US-listed European energy stocks, all of which have US listings.

Is the Healthcare sell-off overdone?
By contrast, there seems to be a different kind of opportunity in Healthcare. The chart below shows that Healthcare stocks (read: Big Pharma) have tracked each other fairly well across the Atlantic for many years. Undoubtedly that can be attributed to the fact that the pharmaceutical business is a global business and these companies sell their products worldwide.

What the chart does show is that while US Healthcare stocks have weakened significantly relative to the SPX recently, their European counterparts have held up quite well. It could be argued that the sell-off could be attributed to a Hillary Clinton comment on drug pricing. If that were true, then shouldn't European drug companies that sell into the American market suffer equally?

This relative performance anomaly is therefore suggestive a relative bargain in US Healthcare stocks.

What I find equally intriguing is that a review of the latest BoAML Fund Manager Survey shows that institutional managers have roughly the same levels of relative exposure to both Energy and Healthcare. When I combine the FMS results with the relative pricing anomalies, it suggests that there are Trans-Atlantic opportunities for traders in these two sectors.

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