European equities stabilized in July in euro terms and were in line with US markets in dollar terms. The Q2 earnings season was better than expected. European countries signed a historic agreement regarding the EU recovery fund (€750billion). Leading economic indicators improved, returning to their pre-crisis levels. In addition, the US election could be a positive catalyst for Europe if the Democrats are elected. Last, but not least, any important news regarding the vaccine should also act as a positive factor. On the other hand, the strained relations between the US and China, coupled with a rise in new infections across Europe, weighed on market sentiment.
The virus is still here, with the last three weeks of July seeing a rise in the new-infection count across the EU, with cases increasing in all countries and by 27% in aggregate, i.e., to the highest level since mid-May. In addition, further local lockdowns in France, Belgium and even Germany may be needed. Spain, in particular, which saw a substantial increase in the daily number of new infections (as the country tried to deal with infection spikes in at least two regions), continues to be a concern.
More stimulus: the recovery fund committed a further €750bn (over 5% of GDP) for 2021-2023, split between €390bn of grants and €360bn of loans. For southern Europe/the periphery, the grants amount to an average of 1% of GDP stimulus for 2021-25.
The UK Gilt yield fell -6.8bps to 0.10%, the German Bund yield -7.0bps to -0.52%, European bonds underperformed the US (as the UK announced a stimulus package worth 1% of GDP), and the EU recovery fund worth over 5% of GDP was approved.
Leading economic indicators continue to improve, The Eurozone flash composite output PMI rose 6.3pts to 54.8 in July – the third consecutive increase after the 13.6 April trough. The series now stands above the pre-virus January-February output.
In Europe, 63% of Stoxx 600 companies beat EPS estimates. Current EPS growth is at -23% year-on-year, surprising positively by +18%. However, this is still better than the extremely low consensus expectations going into the earnings season. In addition, analysts continue to predict that most EPS losses will be offset in the third quarter of 2020. Some sectors will even show slight growth compared to 2019.
Western Europe should outperform the US even though its lockdown was more severe and its peak-to-trough fall in GDP larger. The region has managed its re-opening successfully and has broken the chain that links mobility and the virus. By contrast, data in the US show that this link has not yet been broken in most states. Better crisis management in Europe translates into better prospects for GDP recovery. In addition, the growing Value gap in Europe coupled with a Democrat victory in the US should also help Europe to outperform.
In terms of sectors, Materials and Utilities outperformed. Utilities’ performance was helped by stable cash flows during the Covid crisis, stable yields, the weak US Dollar and the search for positive climate change exposure. On the other hand, Energy underperformed, with this sector boasting the most negative EPS growth. Healthcare also underperformed, with the collapse of the US dollar. Defensive sectors overall fared better than cyclicals
In terms of themes, Small Caps outperformed, while Value stocks underperformed, against an ongoing background of excessively high economic uncertainty. In addition, Growth largely outperformed Value this month, reinforcing the extreme performance gap between the two styles. Value remains at a historic underperformance level.
In our view, as Value should outperform, we are keeping our high conviction on Value stocks – particularly Financials – as they still offer an excellent Risk/Reward ratio. We think that the potential vaccine is going to be a trigger for style rotation, and will allow the economy to normalize and US and European rates to rise.
Why banks within the Value style? Valuation levels are close to 2009 for certain names. Unlike the 2008 financial crisis, banks now have sufficient equity to cope with the 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 a 25-to-50bp extra margin. Last, but not least, the sector is currently massively underowned; any relief from vaccine developments could boost prices.
As a result, we have kept our grade on high-quality Retail Banks as they offer an excellent risk/reward ratio and as we should have positive news regarding a vaccine in the coming months. We are keeping our negative grade (-1) on Communication Services, due to challenging fundamentals (negative growth and declining margins). Finally, we have kept our negative exposure to Utilities (-1), as, globally, it is an expensive, low-growth and low-quality sector (poor profitability and high debt level).
After losing momentum in June, US stock markets resumed their resolutely bullish trajectory in July. US markets were helped by big tech and vaccine optimism, despite a pick-up in infections, fears of a second wave, rising US/China tensions and a failure to agree on the fifth US stimulus package by 31 July. The earnings season was better than expected and leading economic indicators returned to pre-Covid levels. On the other hand, the strained relations between the US and China, coupled with the growing political uncertainty caused by the approaching US presidential elections, weighed on market sentiment. Last, but not least, the Covid-19 pandemic is not at all under control.
The US continued to see a rise in cases, with California, Florida, Arizona and Texas remaining areas of concern.
On the vaccine front, optimism remained fairly elevated in July. Pfizer and BioNTech announced two experimental coronavirus vaccines which received fast-track designation from the FDA. Moderna produced antibodies in all patients tested in a Phase I trial. Results of early clinical trials of the Oxford candidate revealed that the vaccine had generated an immune response.
Q2 earnings continue to print stronger-than-admittedly-low expectations, with 84% of reporting companies beating expectations in the US. In addition, analysts continue to predict that most EPS losses will be offset in the third quarter of 2020. Some sectors will even show slight growth compared to 2019.
Regarding economic factors, the US Treasury yield fell -12.8bps to 0.53%, the US 2Y/10Y -8.5bps to 41.9bps and the US 10Y/30Y -9.0bps to 66.3bps. Treasuries rallied as the US Covid situation caused many states to reverse or slow down re-openings, and the labour market rebound slowed down, with initial jobless claims rising over the last fortnight of July.
PMIs largely rebounded, and the global manufacturing PMI is now higher than it was before the pandemic-led lockdowns impacted the global economy.
The dollar declined, due to a multitude of driving factors, including: the global V-shaped rebound in growth as the shutdown ends and the USD safe-haven bid unwinds; better crisis management in Europe, coupled with the region’s fiscal and structural optimism; and negative idiosyncratic US political and fiscal risks, reinforcing a sense of inverse US exceptionalism playing out.
In terms of sectors, Consumer Staples outperformed, as the sanitary situation in the US continues to strengthen the sector’s results. On the other hand, Energy underperformed, with the sector boasting the most negative EPS growth, while Defensive sectors have fared better.
In terms of styles, Growth continues to outperform. The ongoing decline of the US treasury yield is very supportive of this sector. On the other hand, Value underperformed mainly because of the fears surrounding the spread of the virus in the US, and the rising US/China tensions.
Since our last committee, our overweight positions in the healthcare and new technologies sectors have contributed positively to our performance, as these sectors delivered healthy earnings. On the other hand, we lost out slightly from our tactical exposure to Financials.
We have kept 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 keeping our overweight on Technology, despite relatively high valuations, as this sector has delivered excellent results and has good growth prospects. 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 have kept our positive exposure on 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 this moment to already adapt the portfolio.
In July, with more than 5% in USD, global equity markets extended their strong June uptrend, driven by stronger-than-expected macro recovery data, monetary and fiscal support, early vaccine optimism and a clearly weakening dollar. But the surprising resurgence of the worldwide spread of the Corona virus, as well as the ongoing US-China frictions – both with a potential negative impact on the fragile economic recovery – kept investors looking for quality growth stocks and safe havens, pushing prices of gold, silver and US treasuries to historic highs.
The weak dollar, rising commodity prices and several CBs cutting rates were some of the main drivers behind the emerging market outperformance of recent months.
Asia was strong, as China showed strong PMI and auto sales data, but also rallied on local media talking the market up, later giving up some gains on continued US anti-China news flow and Hong Kong losing its special status.
Taiwan rallied strongly on a strong semi-conductor (especially TSMC) sector, with the tech and consumer sectors also supporting Korea and India.
ASEAN again lagged the regional performance. Improved investor sentiment on economic stabilisation and better oil and commodity prices also drove strong market and currency performances in Latam (Brazil, Chile) and EMEA (S. Africa), while Russia and Turkey continued to lag in July. Sector-wise, Technology, Consumer Discretionary and Materials led the performance, while Financials continued to have a difficult time. As a result, not surprisingly, (earnings) momentum and growth style factors again continued to outperform "value", increasing the already huge gap.
We continued to keep a balanced portfolio, taking some profit on strong performing quality growth stocks and sectors that was then partly directed towards more cyclical stocks, given the extreme but ongoing growth/value valuation divergence. 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 increased our view on the automobile sector, given its attractive valuation and indications of a recovery. We also remain overweight consumer services
Within Financials, we are keeping our negative grade on banks, an industry still under heavy pressure, but remain positive on diversified financials.
Within Materials, we are keeping our positive view, focusing on gold/infrastructure companies, which are more resilient in this context.
Within IT, we are still overweight, more positioned towards hardware and semiconductors rather than software, due to stock ideas and valuation.
Within Communication Services, we favour social media and gaming stocks while being negative on the Telecom industry, a sector facing structural challenges.
We have kept our tactical Neutral exposure to Latin America as this a typical region with high bombed-out value and cyclical content (financials, energy, commodities).