European equities: Upward trajectory
Europe, traditionally more value/cyclical oriented than US, slightly outperformed the US as interest rates steepened.
Stricter sanitary measures have been implemented by the authorities following the accelerating number of new Coronavirus cases in the euro zone. The emergence of new strains is causing a global rise in the reproduction rate. In many EU countries, hospital and ICU bed occupancy rates are becoming critically high.
EU vaccine rollout is still slow. Vaccination in Europe is clearly lagging behind the US. At the current rate, 70% of the population should be vaccinated in Europe by the beginning of 2022, compared to the end of July 2021 for the United States. However, the European goal is to vaccinate 70% of the adult population by summer, which implies an exponential acceleration of the vaccination curve.
The improvement observed in the services sector should be short-lived following stricter sanitary measures. Nonetheless, strong economic survey readings bolster confidence that activity will surge sharply once restrictions are eased thanks to the vaccine rollout.
National governments are maintaining or reinforcing their support for the economy, while the Next Generation EU recovery plan has yet to be ratified by all 27 EU countries. The project was recently challenged in the German Constitutional Court. The ECB will maintain its accommodating stance to preserve favourable financing conditions.
The GDP growth forecast for 2021 was revised downward to 3.9% as the additional restrictions will slow the ongoing recovery in H1. Although delayed, the recovery should gather steam in H2 as most of the population should be vaccinated by then. Despite a weak H1 2021, we continue to expect GDP to be close to its former trend by the end of 2021. Our central scenario assumes that most of the population is vaccinated by Summer 2021, allowing a gradual end of social distancing. Fiscal measures are also supporting the recovery.
Negative earnings growth for the MSCI Europe of -3% is expected at the end of 2021 compared to its end 2019 level. The highest levels of earnings growth are expected in the materials (+44% vs. 2019), Utilities (+14% vs. 2019) and IT (+8% vs. 2019) sectors. These sectors seem to be the winners from this crisis, supported by recovery plans and also accelerating mega-trends such as digitalization. Value sectors such as Energy (-20%), Financials (-12%), Real Estate (-14%) and Industrials (-13%) will remain significantly below their 2019 earnings levels at the end of 2021.
Financials (despite a recent outperformance), Healthcare (a sector with strong earnings but neglected by investors due to its defensive nature), Consumer Staples (also neglected due to its defensive nature) are particularly attractive. While cyclical sectors such as Industrials and Consumer Discretionary appear expensive. The reopening of trade therefore seems to have been almost fully priced-in to the market.
In terms of sectors, IT, Utilities and Communication Services outperformed. On the other hand, Energy underperformed
In terms of themes, growth and quality stocks were the best performers, while value stocks underperformed.
Since the last committee meeting our positive grade on Consumer Staples slightly paid off. On the other hand, we lost on our negative grades on Communication Services and Utilities.
All major rotations towards value stocks in recent years have lasted just six months at the most. In March 2020, COVID-19 fears amplified investment flows, which began to reverse from November 2020. This rotation has now been underway for almost five months. If we believe in patterns, or more seriously, in our monitoring tools and valuation models, we are approaching the end of this rotation period. Two thirds of this market phase is probably behind us. What happens next, in the coming weeks, will depend on whether long-term rates continue to rise towards or beyond 2% in the US and above -0.2% or even 0% in Germany. We believe that the value stocks which are currently benefitting from the style rotation can only dominate if economic growth accelerates beyond the stimulus plans launched by the political and monetary authorities. This acceleration is clearly not our central scenario, given the scale of government deficits and debt levels around the world, particularly in America and Europe.
Our positioning will again favour growth/quality stocks in the coming months, by capitalising on more attractive valuations. We will look for economic segments that are set to accelerate in the coming years, against a backdrop of new regulations, ESG or otherwise, and innovation.
As a result, we lowered our grades on Financials and Banks from +2 to +1. Following the strong YTD rally and since early November, the sector is still attractive but risk reward is now less compelling. This rotation has now been underway for almost five months. If we believe in patterns, or more seriously, in our monitoring tools and valuation models, we are approaching the end of this rotation period.
Finally, we raised our grade on Utilities from -2 to -1 following the strong YTD underperformance of the sector. We remain underweight, although to a lesser extent, as Biden's ESG plan is adding demand in terms of renewable capacity. Finally, US rates have already had a strong run (+100 bps over the last 6 months). We do not believe that US rates can go much further.
US equities: Economic recovery is on its way
US equity markets closed the month higher. The 10-year yield has almost doubled since the beginning of the year. Unsurprisingly, IT stocks underperformed, being the most interest rate-sensitive sector. The same phenomenon was observed in other regions and sectors. The US, traditionally more growth-oriented than Europe, slightly underperformed vs Europe, as did Emerging Markets.
A $2.2 trillion plan financed by an increase in corporate taxes has been proposed by the Biden administration to shore-up US infrastructures. With Republicans unlikely to support a plan with significant funding for “green” initiatives or substantial tax increases, Democrats will probably need to pass the plan through the budget reconciliation process, which would require near-unanimous Democratic support and could result in a trimming in size. Democrats likely will be able to coalesce around a plan, but it may require months of negotiation.
The pandemic has clearly receded, but it is slowly regaining momentum in the north east. The emergence of new strains causing a global rise in the reproduction rate. Hospital and ICU bed occupancy rates are at moderate levels, the situation is far from critical at the moment. Compared to Europe, it seems that new cases and hospitalizations have clearly been curbed by the rapid US vaccination campaign. Vaccine producers are expected to provide 600 million doses, covering the adult US population, by the end of July.
The strong vaccination campaign should support the already robust momentum. After a setback in February, March indicators point to a renewed surge in activity. Business survey data firmed during the month and looked strong overall, including the ISM manufacturing survey’s headline composite hitting its highest level since the 1980s. In addition, close to 1 million jobs were created in March but the total is still more than 8 million fewer than before the pandemic.
We expect GDP to grow by 6.2% in 2021 after a 3.5% contraction in 2020. An above-trend growth scenario is the most likely: it would meet the Fed and Treasury policy objective without necessarily triggering long-lasting inflationary pressures. Our scenario assumes a gradual end of social distancing thanks to most of the population getting a vaccine by summer 2021. Upside risks could materialize if households spend part of their accumulated savings.
The earnings growth of the MSCI US index is expected to be +13% at the end of 2021 compared to its end 2019 level. The highest levels of earnings growth are expected in the materials (+33% vs. 2019), IT (+29% vs. 2019) and healthcare (+27% vs. 2019) sectors. The health sector has been neglected by investors for several months, however, its profitability, growth and long-term drivers remain intact.
Financials (despite a recent outperformance), Healthcare (a sector with good earnings but neglected by investors due to its defensive nature), Consumer Staples (also neglected due to its defensive nature) are particularly attractive. While cyclical sectors such as Consumer Discretionary and Industrials seem to be expensive. The reopening of trade therefore seems to have been almost fully priced-in to the market.
In terms of sectors, Industrials and Consumer Discretionary outperformed as the positive COVID-19 vaccination campaign rollout news increased optimism regarding a strong economic recovery. On the other hand, the energy sector underperformed.
In terms of styles, quality and growth stocks slightly outperformed while Small caps underperformed as some profit taking logically occurred after the recent PMI rally (ISM manufacturing survey’s headline composite hitting its highest level since the 1980s).
Since the last committee meeting our positive grade on Healthcare and Materials paid off. However, we slightly lost from our strong overweight on Financials.
Value stocks represent the pain trade at the moment, as rotation has already been largely completed. Value stocks are dominated by sectors like Financials, Energy and Materials, which are all sensitive to rising growth and inflation outlook. Financials naturally respond to higher yields, while commodities respond to stronger growth/demand and are natural inflation hedges. Inflation is expected to increase above 2% in 2021, before reverting back in 2022. As a result, we believe that the outperformance staged by value stocks is a short-term phenomenon. We are convinced that quality/growth stocks should outperform in the medium / long term supported by sectors with secular growth drivers such as information technology.
All our grades remain unchanged as visibility on the markets remains extremely limited in the short term.
We are maintaining our neutral grade on the IT sector, as it is still too early to increase our exposure. However, it’s a purely tactical move as, although we remain medium and long term highly bullish, rising 10Y interest rates have convinced us to lower our rating in the short term. However, our stance is genuinely neutral and certainly does not signify a sell recommendation, as earnings were healthy again and industry drivers are strong (innovation, IT infrastructure, 5G, semiconductors).
We are maintaining our neutral grade on Consumer Staples The sector has underperformed on the 10-year yield move and valuations are too low to remain underweight.
Emerging Markets: Mixed performances as coronavirus cases surged in some countries
After consecutive months of outperformance, Emerging Markets lost momentum in March, declining by 1.7%, and underperforming developed markets by 4.8%. Global equities returned 3.1% for March, led largely by the US, where the rapid pace of vaccination and massive fiscal and monetary stimulus fuelled growth expectations and drove markets higher. While these factors and inflation concerns led to a 34bp increase in US 10-year treasury rates, the Fed maintained that it was not yet time to intervene/taper. Rising yields strengthened the USD by 2.6% over the month. A number of EM central banks reverted to tightening monetary policy, in keeping with a stronger dollar and rising inflation outlook (Brazil, Turkey, Russia).
Within EMs, growth recovery exuberance calmed as COVID-19 cases surged in some countries while in others, central banks adopted a tighter stance and commented on excessive valuations in parts of the market. China, which is the EM Index's largest weighting, fell by 6.3%, driven lower by heightened regulatory concerns over tech and education heavyweights, combined with ongoing US-China tensions and, later in the month, by the fallout from the Archegos family office liquidation, which had positions in some Chinese tech ADRs.
Taiwan and Korea were flat, returning -0.6% and +0.1% respectively, even with the global semiconductor chip shortage continuing and Intel's announcement of a 20 bn USD plan to set up its own foundry in the US.
India (+2.2%) came under threat from a rapidly rising second COVID-19 wave, resulting in announcements of partial regional lockdowns. The bright spot in EMs were Latam and EMEA, which gained 4.3% and 4% respectively in March, despite the strong dollar dampening sentiment on commodities, with most metals retracing some of their earlier gains, but still well above December 2020 levels. Oil closed the month at $62.4 per barrel, down 3.1% month-on-month, as fresh lockdown measures were announced in different parts of the world.
EM currencies ended the month lower, down 2.5% overall. The Turkish Lira recorded the sharpest downturn, plunging by 10% after the central bank governor was unexpectedly replaced.
Over the first quarter, while still showing gains, a weak March meant that EMs underperformed DMs, with commodity markets such as Saudi Arabia and Chile (+16% in USD) leading and Turkey posting the worst performance (-22%).
In terms of strategy, we reduced our exposure to India after a strong run, downgrading to neutral on COVID-19 resurgence, valuations and potential currency risk.
We are maintaining our grade on Mexico, but may potentially upgrade to +1, as the ongoing value run and US recovery should benefit Mexico - but cyclicals vs ESG considerations.
We are maintaining our grade on Taiwan. We remain constructive on semiconductors/tech - potential upgrade for non-tech. Heightened US-China tension risks could impact Taiwan directly or indirectly.
Potential upgrade on consumer staples given the sector’s defensive profile and recent underperformance - stock picking remains key.
We are maintaining a balanced portfolio, combining value/cyclical stocks and ‘opening-up’ exposure with quality growth stocks and sectors (technology, healthcare, CD) providing some protection for the portfolio against profit-taking in more interest-rate-sensitive and longer-duration growth stocks, which came under selling pressure towards the end of the month. As a result, we now have a more balanced positioning between growth and value stocks and we are reducing the growth bias as a funding source, despite our longer term positive view.