Markit, a financial information provider, has developed a smart beta model that it says can correctly predict 60% of the time which of ten European equity sectors will outperform.
The "sector rotation model" combines Markit's Purchasing Managers Index (PMI) data together with fundamental and momentum investment factors to predict performance of the ten "economic sectors" in Europe, such as utilities, energy and telecommunications.
Markit says back testing the model showed that outperformance of favoured sectors against those that the model did not favour was 50 basis points on average per month over 15 years of history. Over a longer timeframe, the model is equally predictive, Markit says, and adds that there were no extended cycles of underperformance across the full analysis period.
Asked to predict the next outperforming sector, Markit told Funds Europe the technology sector is currently favored due to a mix of signals spanning fundamentals, momentum and positive sentiment based on factors from the credit default swap and securities lending markets, which are among other inputs the model uses in its sector forecasts.
Markit also told Funds Europe that in October 2014, the model correctly predicted the energy sector would underperform, led by weakened momentum and negative sentiment. In the three months since then to January 31, 2015, the energy sector lost about 7% in euro terms, the firm says.
Sector allocation is deemed more important today because country and industry risk factors have become intermingled due to globalisation, meaning it is the common set of underlying drivers for stocks in the same sector that may now provide better signals for major market events.
The sector rotation model was developed by Markit Research Signals.
Markit produces its PMI surveys for over 30 countries. The surveys track variables such as output at selected companies.
©2015 funds europe