European equities: Value outperforming growth stocks
European equity markets started bouncing back at the end of August, extending their gains through September, with the Stoxx 600 rallying from its August lows before paring some of its gains at the end of the month on renewed political risks.
Europe was particularly strong while the US and ASEAN Ex Japan underperformed. As markets pushed higher and global bond yields jumped, reversing some of their movements since August, Value outperformed Growth, in line with the rebound of the 10-year German bond yield.
Regarding growth, data continued to soften but came out very mixed. In the Eurozone, flash PMIs, the German IFO and economic sentiment for September – dragged down by the manufacturing sector – all surprised, notably on the downside (the composite PMI fell -1.5pts, to 50.4 – its lowest level since mid-2013). Regarding political factors, US-China trade negotiations improved slightly.
In Brexit, no progress was made in the EU-UK negotiations. The UK parliament passed a law preventing the government from taking the UK out the EU without a deal on October 31.
We reduced our exposure to Industrials and Consumer Discretionary to be ‘underweight’. The industrial sector has been heavily impacted by the trade war, as the European and Chinese economies are highly correlated. Furthermore, quality stocks in this sector are overvalued. The valuation on luxury is too high, in our view, and has failed to price in the risk from the prolonged tensions between China and the US.
US equities: Solid month
In the absence of catalysts like important earnings news, and with no meaningful evolution in the trade war between China and the US, global stock markets stabilized in September, with the MSCI World up (+2.03%) in line with the S&P 500 (+2.15%) and the Stoxx 600 (+3.44%). Nevertheless, after many years of underperformance, value stocks abruptly started to outperform.
US equities had a solid month over September, with the S&P 500, NASDAQ and the Dow Jones all positive.
The FOMC cut the target range for the fed funds rate by 25bp, as almost universally expected, to 1.75% from 2.0%. Retail sales increased a greater-than-expected 0.4% in August, and sales at the retail control group (ex-autos, gas, building materials and food services) also beat expectations, increasing 0.3%.
While both of these figures came off the blistering pace set in the spring and summer, the trend in consumer spending growth still looks very solid. After incorporating modest downward revisions to the June and July retail numbers, real consumer spending is expanding at about a 3.6% annual pace this quarter, little changed from prior to this data. This leaves consensus tracking of Q3 real GDP still close to 1.5%. Consumers remain the locomotive of the economy, and with labour markets still looking healthy and financial conditions remaining accommodative, there is little reason to expect a near-term retrenchment in retail spending.
We decreased our exposure to Energy to be ‘underweight’ while reducing our Communication Services exposure to ‘neutral’ by taking some profit on Social Media stocks. Despite the shutdown of one of the largest oil refineries in Saudi Arabia, geopolitical tensions in Iran and Venezuela, and OPEC agreements to reduce production, inventory levels are still too high, while world demand for oil continues to moderate. We are rather neutral on Communication Services, specifically on Social Media, as potential regulation might impact the sector, but we are still positive from a long-term point of view.
Emerging equities: Still underperforming
Emerging Markets declined once again, the seventh consecutive month of underperformance.
Global risk-off sentiment, driven by increasing US recession risks and the US-China trade war, lost Emerging Markets 5.1% in August. In Asia, the US-China trade re-escalation, with China retaliating against US President Trump's increased tariffs, weakened market sentiment.
The correction in China was exacerbated by the rising political tensions and demonstrations in Hong Kong, as well as a further depreciation of the Yuan. In India, the RBI’s attempts to boost weak economic growth with a rate cut and fiscal stimulus did not prevent the Indian equity market losing ground.
Korea was hit by trade frictions with Japan, weakening exports and pressuring earnings. In EEMEA, the weakness in the oil price hit both Russia and Saudi Arabia while, in LatAm, profit-taking and a falling Real hit Brazil, partly due to the currency and market crash that hit Argentina following the defeat of the incumbent president in the primary elections.
Risk-off sentiment supported the price of precious materials, while the price of commodities (Brent Crude, copper, ...) plunged. Sector-wise, all saw a negative month, with Real Estate and Financials the worst performers.
We remain positive about ASEAN as a counterweight to our cautious stance in China/South Korea –countries typically less dependent on global trade, given their relatively closed economies. We also remain positive on Brazilian equities, a safer LatAm market than Argentina, which suffered the most following a shock loss for the President in the primary elections. We slightly increased our stake in Russia, based on a positive risk-reward. We also increased our positions in Consumer Staples, Consumer Discretionary and Information Technology while reducing our stake in Industrials. The deal/no-deal situation and hawkish/dovish Fed remain uncertain and we need to adjust our portfolios accordingly.