European equities: Weak start to the year
The year began on an optimistic note, with the early-January Democratic Sweep in the US re-igniting the reflationary narrative. Equity markets got hopeful about the prospect of further fiscal stimulus and bond markets saw a sharp sell-off, with 10Y Treasury yields surging past 1%. However, the market narrative turned less bullish as fiscal hopes dimmed and the poor COVID/vaccine backdrop in the EU took hold.
Infection rates started to rise across the continent, with the UK and Germany going into national lockdowns. The UK in particular suffered from extremely high death and hospitalization rates as a new variant of the virus quickly spread. Vaccinations started to roll out in the EU, though very slowly, particularly in France. However, in the last week of January, we started to see positive results from vaccinations in the UK.
Despite a drop in consumption, GDP was stronger than expected in Q4. January PMI surveys remained surprisingly resilient in the manufacturing sector while still sub-par in the services sector. Restrictions on mobility imposed by governments in order to curb the third wave of infections remained pretty stringent.
The ECB reiterated its message of seeking to maintain favourable credit conditions. Still, tighter bank lending conditions could lead to an incomplete recovery. The vaccination pace, much slower than in the United States or the United Kingdom, should nonetheless accelerate, allowing GDP to return close to its former track by the end of 2021: on average, in 2021, GDP should grow by 5.5%.
Europe has been one of the areas most severely affected by the pandemic. We recorded an EPS drop of -30% in 2020. In addition, 37.7% EPS growth is expected for 2021. Unsurprisingly, the main contributors to this EPS fall were Financials (-8.7%), Industrials (-6.1%) and Consumer Discretionary (-8.7%), with Utilities – supported by the ongoing green transition – the only sector with slightly positive EPS Growth in 2020 (+0.3%).
In terms of themes, Momentum and Small Cap were the best performers. PMI resilience benefited small caps. In addition, valuations remain attractive on high-quality small caps. Value, on the other hand, underperformed.
Despite its recent underperformance, we still think that the rotation has further to run. Economic indicators should continue to improve as the vaccination rate increases. The announced recovery plans should be implemented this year. All these elements should allow the Value/Cyclical rotation to continue in the coming months.
We are keeping our grade on Insurance at +1, as the sector is attractive and especially as long-term interest rates are rising. We are also keeping our strong overweight on high-quality Retail Banks, as they still offer attractive valuations, despite the recent outperformance. The ongoing normalization of the economy should continue to support the sector. US rates are expected to continue to rise, and this should also affect European rates. In addition, earnings are better than estimated and provisions remain low.
Confirmation of our strong underweight on Utilities, which remains a very expensive defensive sector with a very high debt level. The sector is also very sensitive to (ongoing) tensions on long interest rates. Very high level of competition in the renewables sector from both Big Oil and Financials. Increasing bidding competition on renewable energy sites is resulting in decreasing ROE.
We have kept our neutral grade on Household & Personal Care, given its high sensitivity to interest rates. However, in our view, this sector remains a long-term winner.
We are also keeping our negative grade (-1) on Communication Services, because of the challenging fundamentals (negative growth and declining margins).
US equities: Investors still prudent about short-term economic outlook
US equity markets made a solid start to January but, by the end of the month, they had given up most of the gains, as investors remained prudent about the short-term economic outlook. In the last week of January, a short squeeze was triggered by retail investors piling into some of the most shorted stocks, which explained the volatility of the overall market. The move led to the biggest Wall Street pullback since October. It also further fuelled bubble fears and valuation concerns.
Although the epidemic is far from under control, the first effects of the vaccination campaign are beginning to be felt in the US, where the number of daily contaminations is strongly decreasing.
The resurgence of the epidemic slowed the recovery in Q4 but momentum remains robust, especially for investment. ISM surveys are pointing to further growth ahead even though the manufacturing sector is experiencing some supply constraints.
Consumption bounced back in January after a weak end-of-year. However, consumer confidence is still well below its pre-crisis level.
More stimulus is expected from the new administration. The American Rescue Plan (worth $1.9 trillion), comprising extra support to households, with a new cheque of $1400 and extended unemployment benefit until September, is now under discussion.
After contracting by 3.5% in 2020, GDP should increase by 4.9% in 2021. Our scenario assumes a gradual end to social distancing, thanks to most of the population being vaccinated by summer 2021. We expect around $1 trillion of additional COVID aid to pass. Upside risks could materialize if the fiscal support were to be larger than expected and/or if households spend part of their excess savings.
The US economy proved to be more resilient than expected in 2020. We recorded an EPS drop of -9.5% in 2020. In addition, 22.4% EPS growth is expected for 2021. Unsurprisingly, the main contributors to this EPS fall were Financials (-3.7%), Energy (-3.5%) and Industrials (-2.3%). Consumer Staples, IT and Healthcare, on the other hand, recorded positive EPS growth of respectively 0.3%, 1.3% and 1.7%, allowing the US to mitigate its global EPS decline.
In terms of sectors, Communication Services and Information Technology outperformed, while Materials underperformed, following short-term economic uncertainties.
In terms of styles, Small Caps and Growth outperformed. Naturally, Value underperformed following the new lockdown measures, reminding us that we are not yet at the end of this pandemic.
Since our last investment committee, our positive grade on Information Technology and our neutral grade on Real Estate have paid off. Our overweight on Financials, on the other hand, cost us, despite rising interest rates. Our positive grade on Materials also cost us, following short-term uncertainties regarding the evolution of the pandemic.
Despite the underperformance of the Value style in January, we still think that the rotation has further to run. Economic indicators should continue to improve as the vaccination rate increases. US rates are expected to continue to rise, and this should support Financials. The announced recovery plans should be implemented this year. All these elements should allow the Value/Cyclical rotation to continue over the coming months.
As a result, we have kept all our grades unchanged.
We are keeping our grade on Materials, as this sector has always benefited from recovery plans and should once again strongly benefit from them.
We are keeping our grade on Consumer Staples, given the recovery from the pandemic allowed by the vaccine. This sector is too defensive.
We are keeping our overweight on Banks, as the rotation has, in our view, further to run. Moreover, the US 10Y treasury yield is now constructive for the sector.
We are keeping our neutral grade on Media/Entertainment, as Joe Biden could raise taxes on these companies. This sector has suffered from the ongoing cyclical rally. We are keeping our overweight on Technology, as fundamentals remain solid, with secular growth drivers. We are keeping our neutral grade on Consumer Discretionary, where the upside is now limited to specific names. Moreover, it is a very heterogeneous sector, with companies like Amazon dominating and many losers. Investment in this sector requires good stock-picking.
We are keeping our neutral grade on Industrials, as this sector has limited upside, given the recent outperformance and relatively expensive current levels of valuation.
Finally, we are keeping our positive exposure to Healthcare, given its decent valuations (especially from a historical perspective) and resilience during the current COVID-19-driven economic slowdown. The political background remains reasonable and the slight majority only that the Democrats have in the Senate makes drastic changes in the US healthcare system less likely. Most Republicans and even some Democratic senators would probably oppose a really progressive healthcare agenda. Still, the topic of drug prices will come up (though probably not as a number one priority for new legislation) from time to time and could cause volatility. We do not expect drastic changes and see the healthcare sector and most of its sub-sectors as an interesting long-term performer.
We are keeping our neutral grade on Consumer Discretionary, where the upside is now limited to specific names. Moreover, it is a very heterogeneous sector, with companies like Amazon dominating and many losers. Investment in this sector requires good stock-picking.
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. The political background remains reasonable, and the slight majority only that the Democrats have in the Senate makes drastic changes in the US healthcare system less likely.
Emerging Markets: cyclical rally has further to run
January started with strong gains for global equity markets, as, in the US, Democrats gained control of the Senate, paving the way to a larger stimulus package. The party, however, petered out towards the end of the month, as markets, finding themselves running ahead of expectations, became weary of exuberance and frothy valuation in certain pockets.
The developed world has tackled COVID with stimulus of unimaginable scale boding well for emerging markets, which remain sensitive to global economic growth. As a result, and supported by a weaker dollar and the return of growth expectations, emerging markets continued their relative outperformance for a second consecutive month. Supported by strong fund inflows, the MSCI EM posted gains of 3.0% in January, as opposed to a 1.1% decline for developed markets.
At regional level, Asia did best, with Tech heavy Taiwan – driven by solid results – gaining 6.5%, while the MSCI China rose 7.4%, with better-than-expected real GDP growth of 14.9% qoq lifting expectations of a sustained recovery. India, which saw some profit-taking, posted a 2.4% decline while awaiting clarity on the next set of financial budget figures. Outside Asia, a key detractor was Latam, whose 6.8% loss countered the strong December gains. EMEA posted a decent +1.1% gain, with Gulf countries outperforming, whereas Russia (-2.8%) and Turkey (-3.5%) remained detractors.
At sector level, growth recovered, with outperformers Communication Services, Consumer Discretionary and Technology posting, respectively, gains of 12.5%, 7.2% and 5.1%, whereas Utilities and Real Estate lagged, with declines of 3.6% and 3.4%. Commodities continued to get stronger, with metal prices up, but especially with WTI Crude gaining 7.6% in January, when Saudi Arabia announced a surprise additional 1 million barrel production cut. On the currency front, EM currencies lost some ground to the USD towards month's end, with US treasury yields (10-year) spiking to 1.07%.
We ourselves believe that the cyclical rally has further to run. Economic indicators should continue to improve as the vaccination rate increases. US rates are expected to continue to rise. The announced recovery plans should be implemented this year. All these elements should allow the Value/Cyclical rotation to continue.
As a result, we increased our grade on India from 0 to +1. Economic data are improving, with the budget for 2021 focusing on growth and adding exposure to cyclicals (Financials and Materials)
We also increased our grade on Media & Entertainment from -1 to 0, with Alibaba (large benchmark weight) recovering and other portfolio holdings such as Bilibili doing well, too.
We are keeping our grade on Financials, as we think the value run should continue. Within Financials, we are mainly positive on selected traditional banks, stock exchanges and niche players such as online brokers benefiting from the current market environment + Fintech: thematic tailwind (growing competition for banks).
We are keeping our positive grade on Automobiles & Components, given the ongoing cyclical rally, not least towards the electric vehicles thematic.
We are keeping our neutral grade on Consumer Services, given its high valuation. In addition, this sector should continue to suffer from the ongoing rotation, given its defensive bias.
We are keeping our neutral grade on retailing, due to rich valuations on stay-at-home stocks (E-commerce).
We are keeping our grade on Healthcare Equipment, given the current market rotation. However, in our view, this sector remains a long-term winner.
We are keeping our positive grade on Latin America, as this is a typical region with high bombed-out value and cyclical content (Financials, Energy, Commodities). The ongoing value rally should benefit the region.
We are keeping our grade on transportation, as valuations are attractive. Stocks, severely punished, are starting to recover on the back of the reopening/vaccine. Risk/reward is clearly to the upside.
We continued to keep a balanced portfolio, combining value/cyclical and ‘opening-up’ exposure with quality-growth stocks and sectors (technology, healthcare, CD). As a result, in terms of styles, we are more balanced between growth/value and are reducing the momentum bias as a funding source, despite our longer-term positive view.