19 OCT



Economic recovery waiting for more visibility


European equities: Range-bound markets

After having reached record highs in August, the global stock market gave up some of its recent gains in September. There are a number of reasons one can think of to explain this albeit very mild correction, but none is new or has aggravated performance recently. The main factors of underperformance are: the COVID-19 narrative, concerns over the durability of global economic recovery, growing geopolitical risks.

European equities remained range-bound. France and Spain underperformed in light of a second wave of infections  whilst Sweden and Switzerland held up the best. Germany outperformed, as the country announced an extension to its job subsidy scheme and the manufacturing sector continued to outperform its euro-area peers. Spain lagged amid a pick-up in infections. The UK continued its underperformance ahead of October’s fiscal cliff and Brexit stalemate.

The daily number of new COVID-19 cases rose in Europe. The COVID-19 infection picture worsened across most of Europe throughout September. France, Spain and the UK were among the worst-affected countries, all seeing growing infection rates though hospitalization/fatality rates still remained fairly low. The worsening infection picture was met with tighter restrictions and/or partial lockdowns across most countries in Europe, with concerns growing of even tighter measures to come. On the positive front, Europe is launching an accelerated review of the Pfizer-BioNTech candidate vaccine.

Valuations are high in Europe, close to pre-COVID-19 levels, with most sectors treating above their average 12M Fwd P/E. Only the financial sector is below its historical average.

Regarding economic data, while September flash PMIs pointed to a continued expansion of the manufacturing sector, the services sector once again lagged. Growing COVID-19 infections are clearly affecting the economic outlook in the region.

Geopolitical risks became much more widespread throughout September. In addition to continued US-China trade hostilities, Brexit uncertainty was back on the agenda and tensions brewed between Germany and Russia, too.

In terms of sectors, Consumer Discretionary and Information Technology outperformed. Energy, on the other hand, underperformed, as the barrel could remain low for a long time. In addition, this sector – along with Financials – stands out with the most negative EPS growth, with investors afraid of the impact of a second wave of COVID-19 on the sector.

In terms of themes, Momentum and Small Caps outperformed, while Value was once again the worst performer, despite attractive valuations.

Growth continued to outperform Value in September. The outperformance of the Growth style versus the Value style is at an extreme level.

The vaccine could mark the low in Growth vs Value, triggering a market rotation (given the valuation extremes) whereby laggards become leaders.

Why banks within the Value style? The ECB is moving closer to lifting the bank dividend ban. Valuation levels are close to 2009 for certain names. In contrast to the 2008 financial crisis, banks now have sufficient equity to cope with the shock. The equity was further improved by the dividends ban imposed by the ECB. In addition, non-performing loans are currently overestimated by the markets and TLTRO offers 25 to 50 basis points of extra margin. Last, but not least, the sector is currently massively under-owned, and any relief from vaccine developments could boost prices.

We tactically decreased our grade to neutral on Household & Personal Care for profit-taking, as this sector has limited upside, given the recent outperformance and its high sensitivity to interest rates. However, in our view, the sector remains a long-term winner.

We are keeping our grade on high-quality Retail Banks, as they offer an excellent risk/reward level and as we should have positive news regarding a vaccine in the coming months.

We are keeping our negative grade (-1) on Communication Services because of their challenging fundamentals (negative growth and declining margins).

Finally, we are keeping our negative exposure to Utilities (-1), as this sector is, globally, expensive, low-growth and low-quality (poor profitability and high debt level). In addition, the sector is very sensitive to any tension regarding long interest rates, which we expect in the coming weeks and months.


US Equities: Major US stocks in the red in September

US equity markets underperformed, with major indices falling in September, after logging five straight monthly gains. Focus was on the weakness in Big Tech, a group that retracted after having driven the market higher since March. In addition, investors are starting to get more nervous about the presidential elections in the US, as the race to the White House is intensifying and the outcome could potentially impact their equity holdings. Moreover, COVID-19 is accelerating again in many parts of the world, and could clearly hamper the still-fragile and early global recovery. Last, but not least, the US is very likely to need more fiscal packages in the coming months to withdraw from this crisis.

The number of COVID-19 cases is increasing. In the US, although the number of infections/hospitalization rates remained relatively subdued throughout September, there were, towards the tail-end of the month, signs of another wave potentially emerging. On a more positive front, after a brief pause, the Oxford vaccine trials were resumed. In addition, Europe is launching an accelerated review of the Pfizer-BioNTech candidate vaccine.

Economic momentum is showing signs of fading. September was a mixed month, too, with the US labour market remaining resilient but some other indicators, for example, the flash non-manufacturing PMI (which cooled from 55.0 to 54.6 vs manufacturing, which rose from 53.1 to 53.5), pointing to slower growth.

After the forceful response of the authorities, fiscal support is now waning. Trump decided to suspend negotiations about the size and the content of additional stimulus until the results of the elections. The main conclusion from the revision of the Fed monetary strategy is that rates will remain low for even longer. The Fed cannot, however, do much more to support growth.

2020 GDP should contract by close to 5%. The shape of the recovery will very much depend not only on the spending behaviour of high-income earners, but on the availability of consumer credit. Firms’ investment behaviour could recover quicker than feared, thanks partly to the Paycheck Protection Program loans morphing into grants. The presidential election should now take centre stage: an uncertain or contested result could end up weighing on business and consumer confidence.

Valuations are high in the United States, with most sectors treated above their average 12M Fwd P/E. Only the healthcare and financial sectors are below their historical average.

In terms of sectors, utilities and industrials outperformed as investors began to reposition their investments towards a normalization of the economy by the year 2021. Energy, on the other hand, underperformed, and the barrel could remain low for a long time. Communication services also underperformed, with investors fearing a Biden election. The candidate could raise taxes on these companies.

In terms of styles, Small Cap outperformed, while Value underperformed, despite attractive valuations.

News flow around the vaccine will intensify in the coming weeks as some companies are at the final stage of human trials. The vaccine could mark a low in Growth vs Value, triggering a market rotation (given the valuation extremes) whereby laggards become leaders.

We tactically decreased our grade on Media/Entertainment to neutral as we await more visibility regarding the elections, since Biden could raise taxes on these companies. We are maintaining our positive exposure to Banks. We think that the potential vaccine is going to be a trigger for style rotation, allowing the economy to normalize and US rates to rise. We are maintaining our overweight on Technology, despite the recent downtrend, as the technical analysis remains positive, with solid fundamentals and secular growth drivers. We are keeping our neutral grade on Industrials, as this sector has limited upside, given the recent outperformance and relatively expensive valuation at current levels.

Finally, we are keeping our positive exposure to Healthcare, given its decent valuations (especially from a historical perspective) and resilience in the current COVID-19-driven economic slowdown. However, although we are closely monitoring the American elections, the situation is too unclear at the moment to already adapt the portfolio.


Emerging Markets: Interruption of the V-Shape recovery

September saw global and emerging markets interrupt the relentless V-shape market recovery since the deep bottom reached in March.

Despite the MSCI EM losing 1.8% in USD, Emerging markets still managed to outperform Developed markets. A combination of uncertain drivers saw investors take some profit or look for potential rotational movements, including: volatility in (improving) economic data, a second wave in Europe of the COVID-19 spread, the inability of US Republicans and Democrats to reach agreement on another fiscal package, growing US election fever (and uncertainty over the result), some rotation out of the 2020 winning tech and healthcare sectors, and the ongoing US attack on China in the technology space. Nor did a strengthening of the USD and a price correction in the commodity space help support sentiment.

Among EM regions, Asia outperformed, as mainly North Asian markets (with the exception of China) and India performed well. China had a difficult time, not least through being battered by the ongoing US attacks on TIKTOK, WeChat and SMIC. Latam suffered, due to weakness in commodity-driven markets like Brazil and Peru, while Russia, too, had a difficult month. Despite some weakness, technology and consumer discretionary were still the best sectors, while healthcare and energy saw most selling pressure.

The weak DXY dollar, rising commodity prices (oil, silver, copper) and several CBs cutting rates were some of the main drivers behind the EM outperformance of recent months. The Indian rupee, Chinese yuan and Mexican peso were the best-performing currencies during the month.

News flow around the vaccine will intensify in the coming weeks as some companies are at the final stage of human trials. The vaccine could mark a low in Growth vs Value, triggering a market rotation (given the valuation extremes) whereby laggards become leaders.

As a result, we increased our grade on India, as the country’s economic data are improving.

We increased our grade on transportation, as valuations are attractive. Stocks, although severely punished, are expected to recover on the back of a reopening/vaccine. Risk/reward is clearly to the upside.

We continued to keep a balanced portfolio, taking some profit on strong-performing quality Growth stocks and sectors. We are gradually adding some reopening stocks (Airlines, Restaurant Chains, Physical Retail) that are still in the upper part of a low-quality spectrum. Those are gradual moves in a low-rate, low-growth environment; over the next 12-18 months, although we will probably see Growth outperforming, there’s a rising risk of a low-quality rally, given valuation extremes. In terms of styles, we are more balanced between Growth/Value and are reducing the Momentum bias. The US election is moving markets – as polling data suggests Biden’s lead is growing in battleground states, further reducing the chances of a contested result. Outlook: reflationary cyclicals and re-opening beneficiaries to outpace YTD stay-at-home winners; market to assume larger stimulus under sweep scenario. Long end of yield curve to steepen. Still, the final election result remains unpredicatble, given the low reliability on polls. 

We remain underweight Utilities and Consumer Staples, as neither sector is cheap and should underperform in a risk-on environment. Within Consumer Discretionary, we are keeping our positive view on the e-commerce and automobile sectors. We also remain overweight Consumer Services. Within Financials, we are reducing our UW in banks, given the strong YTD underperformance but still see the industry as a whole under heavy pressure, and remain positive on diversified Financials. Within Materials, we are keeping our positive view, focusing on gold and copper (infrastructure), given the tailwinds of economic reopening. Within IT, we are still overweight, more positioned towards hardware, semiconductors rather than software due to stock ideas and valuation. We’ve been trimming the OW here. Within Communication Services, we favour social media and gaming stocks while being negative on the Telecom industry, as this sector faces structural challenges. 

We are keeping our tactical Neutral exposure to Latin America as this a typical region with high bombed-out value and cyclical content (Financials, Energy, Commodities). A Value rally would benefit the region, though.