The global stock market continued its spectacular rebound in May, even after a stellar return in April. Is the world economy out of the woods yet? Clearly not. Most macro-economic indicators are still in the deep-red zone. But the gradual reopening of the world economy after several months of lockdown, coupled with gigantic stimulus packages in every part of the world, have inspired investors to look beyond the current economic situation. Value stocks, which were significantly lagging the rest of the market on almost every time horizon, clearly outperformed.
European equities had a strong rally in May, with investors, shrugging off rising political tensions, still optimistic about the global economic outlook. European states continued to ease their strict measures as there was no evidence that the lifting of the lockdowns was leading to rising infection levels. Responses from central banks and governments continued but none were significantly incremental. Moreover, the European Commission proposed a €750bn recovery fund made up of €500bn in grants and 250bn in loans.
Regarding economic data, 1Q GDP fell -14.2%, broadly in line with the flash reading. In addition, the 1Q20 employment rate growth stood at -1%q/q. Most leading economic indicators – while still in the deep-red zone – are starting to recover from the crisis with the gradual reopening of the world economy. Q1 results were, mostly, slightly better than feared.
In our view, the European economy should offset most of the EPS losses by 2021, in line with the potential strong economic rebound.
As we expected, Financials, Energy, Automobiles and Industrials strongly outperformed at the end of May and beginning of June, as these sectors were priced for the worst-case scenario and are now, with the cyclical rally, outperforming. On the other hand, HealthCare and Consumer Staples, which have performed particularly well since the beginning of the crisis, started to lag. In terms of style, Value and Small Caps strongly outperformed, and continue to offer attractive valuations.
We are keeping our high conviction on Value stocks, as this style – particularly Financials – still offers very attractive valuations. The value gap is still extreme and market positioning is still notably absent. In addition, in contrast to the global financial crisis, banks’ capital is sufficient to withstand this period of stress.
As a result, we'll continue to closely monitor the performance of the Value style during the market recovery of the coming weeks and months. In our view, it's very likely that the rally on this style will continue, as PMIs should continue to improve.
Our overweight on Automobile and strong overweight on Banks have paid off since the last committee. However, we will reposition our funds toward more Quality/Growth names when the Value-style valuation gap normalizes.
In our view, the level of deficits and public debt around the world will have a negative impact on global GDP in the next 5 years. Therefore we favour Quality/Growth in the long run.
As a result – and based on very attractive valuations – we are keeping our strong conviction on retail banks. We are also keeping our short on Insurance as Insurers’ solvency ratios have sharply decreased. Although we are keeping our positive view on Automobile, as price discounts remain attractive, we are looking for an exit strategy. We'll continue to closely monitor the performance of the Value style during the market recovery of the coming weeks and months, when we believe the Value style should continue to outperform. In addition, we are also keeping our positive exposure to Household/Personal Products and Food/Beverage, as they still have attractive valuations and resilient revenues, and offer good returns to shareholders.
Virus cases continue to rise in the US, although the growth rate is slowing; many activity restrictions remain in place, though all 50 states have taken measures to ease the lockdowns. The US economy faces unprecedented risks from the coronavirus if fiscal and monetary policymakers don’t rise to the challenge, according to Fed Chair Powell. In addition, more stimulus, particularly fiscal, may be necessary, given the high level of uncertainty regarding the current economic outlooks.
Regarding economic indicators, jobless claims spiked, with a 20% unemployment rate in the country in May. However, the employment report of 5 June showed a significant improvement in the employment situation. Non-farm payroll employment rose by 2.5 million in May and the unemployment rate declined to 13.3 percent. These improvements in the labour market reflected a limited resumption of the economic activity that had been curtailed in March and April due to the coronavirus (Covid-19) pandemic and the efforts made to contain it. Activity recovery has started, with almost all States reopened. The Non-manufacturing ISM slightly improved in May.
Renewed tensions between the US and China, and the political context, which has been further degraded by the recent exacerbation of racial tensions, are all risks for the rest of the year.
We continued to see some equity inflow at the beginning of June. Moreover, leading economic indicators should continue to improve in the coming months, as economic activity restarts.
As could be expected since our last committee, Value stocks such as Finance, Energy and Industrials – which were significantly lagging the rest of the market on almost every time horizon – clearly outperformed, as price discounts were extreme. On the other hand, defensive sectors (e.g., Healthcare and Consumer Staples), which have performed particularly well since the beginning of the crisis, continue to lag.
Despite the current Value run, Growth is still very expensive compared to Value, especially when you look at Financials. That is why we think the Value run could extend over the coming weeks.
In our last committee, we increased our Financials exposure to overweight. This tactical bet was taken at the right time and generated a strong outperformance. On the other hand, our overweight on IT, Healthcare and Communication Services weighed on our performance, as these sectors are close to strong resistances levels.
We decreased our overweight on Technology, from +2 to +1, for profit-taking. We increased our exposure to Industrials, as this sector still offers attractive valuations (possible extension of the Value run). We are keeping our grade on high-quality banks as the sector still offers attractive valuations. In addition, we think that the Value run could extend throughout the coming weeks. We decreased our overweight on Information Technology, from +2 to +1, for profit-taking. We are also keeping our overweight on Communication Services exposure, based on attractive valuations, while regulatory constraints are no longer a top priority, given the current economic context. Finally, we are
Emerging Markets rose 0.6% in May, while underperforming Developed Markets by 4%, as the earlier optimism on an overall globally slowing coronarivus infection rate, easing lockdowns and hopes of a potential vaccine – added to 11 EM central banks cutting rates during the month – dwindled due to rising market worries over a re-escalation of US-China tensions.
Oil prices strongly recovered in May, thanks to renewed demand and expectations of global supply cuts. Other commodities also bounced back, with gold prices up amid weak US data and escalating US-China tensions.
In Asia, China weakness amidst the US-China tensions on trade expanded to Tech (Huawei supply restrictions), Financials (ADR listings) and geo-politics, with a fierce reaction from the US, and demonstrations in Hong Kong against the approved Chinese Security Law for Hong Kong. India also underperformed, amidst the severe spread of covid-19 despite the announcement of a 10%-of-GDP special economic package, and Taiwan fell as well, with Tech underperforming. LatAm performed best, with Mexico and Brazil (despite a deteriorating Covid-19 and political situation) strongly up, as global value trade gained momentum, and even Argentina, too, up (despite debt-default risk), all thanks mainly to a strengthening currency. EEMEA rose, with Poland and Russia rising, as oil prices rose during the month.
The dollar fell, with the Mexican peso, Russian rubble and Colombian peso the best-performing currencies.
Among sectors, Healthcare, Consumer Discretionary and Energy topped the charts, with Tech and Financials lagging in May.
We increased our exposure to Financials from underweight to neutral. Since late May, given the growth/value valuation extreme, we have started to reduce portfolio risk by adding some cyclicals. In early June, portfolio risk reduction included a pronounced move towards cyclicals, especially in Financials, but also in Materials (less gold, more bulk/base metals), Industrials and Energy (upstream), which was funded mostly by Healthcare and parts of IT.
We decreased our exposure to HealthCare from overweight to neutral for profit-taking (high valuations). This profit-taking was also a good way to fund our Cyclical Value exposure.
In late May, we tactically increased our exposure to Latin America from underweight to neutral in order to add exposure to a typical region with high bombed-out value and cyclical content (Financials, Energy, Commodities), while remaining not structurally supportive, as the economic and Covid-19 situation remains difficult in the region. Political tensions, too, continued throughout May.