European equities continued to benefit from the €750 billion EU recovery fund, wiping away the Covid-19 correction that started at the end of February 2020. However, Europe still lagged the US market, in the absence of large tech companies and taking into account Europe’s Value tilt. However, the Value bias could be the main driving force in Europe in the coming months, in the case of the economic normalization allowed by the vaccine. Moreover, for a few days now, we have been seeing some signs of this style rotation.
The daily number of new COVID-19 cases rose in Europe, particularly in Spain and France. So far, a better testing and tracing capacity has allowed European policymakers to treat this second wave with targeted measures (such as wearing masks outdoors, or closing bars, nightclubs and amusement parks) instead of national lockdowns. While growing concerns of a second wave across the region have weighed on markets, it is worth noting that death rates and hospital admissions have been falling, even in the worst-affected countries.
In terms of economic data, the latest Eurozone business surveys (PMIs) pointed to slower expansion in the services sector (50.1), amid an upturn in virus outbreaks in the region. Manufacturing output, however, remained strong – while below pre-pandemic levels – and overall economic sentiment (87.7) in the Eurozone edged higher for the fourth consecutive month, confirming the gradual rebound.
In terms of sectors, Consumer Discretionary, Industrials and Materials outperformed, as investors begin to reposition their investments towards a normalization of the economy by 2021. Quality stocks of cyclical sectors were the main beneficiaries of this new positioning. In addition, news flow around the vaccine will intensify in the coming months, as some companies are at the last stage of human trials – this being one of the main reasons for the Cyclical/Quality outperformance. The vaccine could mark a low in Growth vs Value and trigger a market rotation (given the valuation extremes), transforming the laggards into leaders. On the other hand, Energy, a standout with the most negative EPS growth, underperformed.
In terms of themes, Small Caps and Quality outperformed, while Momentum underperformed.
Why banks within the Value style? Valuation levels are close to 2009 for certain names. In contrast to the 2008 financial crisis, banks now have sufficient equity to cope with this shock. The equity was further improved by the ECB dividend ban. 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 underowned; any relief from vaccine developments could boost prices.
As a result, 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 the vaccine in the coming months. We are keeping our negative grade (-1) on Communication Services, challenging fundamentals (negative growth and declining margins). Finally, we are keeping our negative exposure to Utilities (-1) as it is, globally, an expensive, low-growth and low-quality sector (poor profitability and high debt level). We decreased our Overweight on Automobile to Neutral, in view of the strong performance since the Covid crisis and less attractive valuations. In addition, there is now the risk of a hard Brexit, with a potential impact on German automobile manufacturers.
US equity markets outperformed in August, despite the inability of the White House and congressional Democrats to reach a deal on a fifth coronavirus relief package. The Nasdaq rallied sharply to reach new highs (its best August performance since 2000) as Big Tech continued its rally till the beginning of September. In addition, daily virus cases declined throughout the month.
US corona virus cases peaked, with daily case growth continuing to trend downwards. In addition, vaccine developments also improved: three of the major vaccine candidates (Astra/Oxford, PFE/BNTX, and MRNA) are in Phase 3 trials and JNJ should get there by the end of September.
On the economic front, most data releases continued to point to continued (though moderating) growth in August. The flash PMIs for both manufacturing and services both beat expectations. However, other advanced economic indicators, including the Consumer Confidence Index (Michigan), fell.
In Commodities, oil rose as US stockpiles decreased, demand prospects rose with the global reopening and hurricane Laura threatened supply on the US gulf coast.
In terms of sectors, Consumer Discretionary, Materials and Industrials outperformed, as investors begin to reposition their investments towards a normalization of the economy by the year 2021. Quality stocks of cyclical sectors were the main beneficiaries of this new positioning. News flow around the vaccine will intensify, as some companies are at the last stage of human trials – one of the main reasons for the Cyclical/Quality outperformance. The vaccine could mark a low in Growth vs Value and trigger a market rotation (given the valuation extremes), transforming laggards into leaders.
In terms of styles, Growth and Quality continue to outperform, while Small Caps underperformed.
Our overweights on Financials and Media, and our underweight on Telecom Services, paid off, while we lost out slightly from our positive exposure to IT and Healthcare.
The big question regarding IT stock is whether this is only a hiccup or the beginning of a big top, and a simple answer is that we don’t know. However, what we do know is that this sector still has secular growth drivers and solid fundamentals.
We are keeping our positive exposure to Banks. We think that the potential vaccine is going to be a trigger for style rotation and will allow the economy to normalize and US rates to rise.
We are keeping 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.
We are also keeping our overweight on Media/Entertainment, as Social Media are the great winners of the current context.
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, we will closely monitor the American elections, although the situation is too unclear at this moment to already adapt the portfolio.
Early vaccine optimism, US and Chinese commitment to a phase-1 deal, and the Fed's relaxed attitude towards inflation helped Emerging Markets rise 2.1% in August, while underperforming DMs by 4.4%.
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.
Asia was the best-performing region, with China showing strong economic recovery across both manufacturing and services industries. Our economic team expects the economy to recover to pre-Covid levels before year-end. Nonetheless, we’ve been trimming exposure there, given the strong YTD performance, especially in the A-shares market.
India rose, thanks to earnings upgrades and investor inflows – despite a sharp increase in daily new COVID-19 cases – meaningfully underperforming peers YTD. GDP contracted more than expectations, due to India-China tensions on border issues.
EEMEA rose, with Russia clearing the world's first COVID-19 vaccine. However, Russia has a strong negative YTD contribution, due to its high exposure to the energy sector.
LatAm fell in August, as Chile was hit with macro and political events and Brazil suffered from currency devaluation and an increase in political noise, as well as some profit-taking following a strong June-July performance.
Sector-wise, the materials, industrials and consumer discretionary sectors (the latter driven primarily by the sharp increase in e-commerce platforms in China) led the performance, while Value stocks lagged their growth counterparts yet again.
News flow around the vaccine will intensify in the coming months, as some companies are at the last stage of human trials – one of the main reasons for the Cyclical/Quality outperformance. It is important to note that the vaccine could mark a temporary low in Growth vs Value and trigger a market rotation (given the valuation extremes), transforming laggards into leaders.
As a result, 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) still in the upper part of a low-quality spectrum. Those are gradual moves in a low rates, low-growth environment. Over the next 12-18 months, we will probably see Growth outperforming but 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.
We upgraded to 0 the Pharmaceuticals, Biotechnology & Life Sciences sectors but we need to be selective. We upgraded the sector, given decent valuations and resilience on specific stocks.
We remain underweight on Utilities and Consumer Staples exposure, as both sectors are not 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. Also, we remain overweight Consumer Services. Within Financials, we are reducing our UW in banks given the strong underperformance YTD 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) companies, which are more resilient in this context. 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).