European equities: Strong rally in June
The global stock market was the plaything of Bulls and Bears in June, with no clear direction and no clear winner. The Bulls pointed to the massive stimulus packages all over the world, combined with a gradual reopening of the world economy (especially in Asia and Europe). The Bears focused on deep-red macro-economic indicators and the ugly evolution of the Covid-19 virus in the Americas and in India.
European equities increased in June, showing resilience against rising geopolitical tensions and the ugly evolution of the Covid-19 virus in the Americas and in India. European countries continued to respond to the pandemic crisis by increasing fiscal stimulus, with the European Commission proposing a €750bn recovery fund.
Leading economic indicators continue to improve, Q2 GDP estimates were revised upwards and oil was driven higher as countries continued to reopen and demand prospects increased with better global growth. In addition, after what appears to have been a strong start to the global recovery in May, business surveys continued to move higher in June.
The V-shaped recovery seems to be confirmed: analysts predict that most EPS losses should have been offset. Some sectors should even show a slight growth compared to 2019.
In terms of sectors, Utilities and Information Technology outperformed. IT should continue along this path due to its exposure to changes in habits related to Covid-19. On the other hand, Consumer Staples, which has particularly well performed since the beginning of the crisis, lagged in June. Energy also underperformed, with fears of a second wave weighing on the sector.
In terms of themes, Cyclicals outperformed Defensives, while Value gained after its intra-month rally before trailing in the later weeks. European equities largely outperformed US equities as the latter fought a pick-up in infections, political tension and an outbreak of protests. June was the first full month of outperformance (versus the US) since September 2019. This outperformance was helped in part by a rotation into cyclical and value stocks from the beginning of the month to 8 June.
In our view, as the value run should continue, we are keeping our high conviction on Value stocks – particularly Financials – as they still offer very attractive valuations and should continue to outperform in the case of a stabilization of Covid-19 cases and improving economic indicators. In our view, it's very likely that the rally on this style will continue if the macro scenario continues to improve and definitely in the case of good news regarding the vaccine.
Low interest rates and the flattening of the yield curve will also be two important variables for value-style performance. However, we believe that the current yield level of US treasuries is too low (because of the flight to safety), taking into account the improving economic situation, and should increase and affect European yields in the coming months.
As a result, we increased our grade on Insurance to neutral, given our view on interest rates. We decreased our exposure to Household & Personal Care, as this sector has limited upside, given the recent outperformance and relatively expensive valuation at current levels. We decreased our exposure to Consumer Staples from +1 to neutral. We'll continue to closely monitor the performance of the Value style during the market recovery in the coming weeks and months, and we believe it should continue to outperform in the coming weeks.
US equities underperform RoW
In another solid month of performance for financial markets, US equities moved higher, after a strong May, though US equities underperformed the rest of the world as the country fought a pick-up in infections, political tensions and an outbreak of protests, and as Biden took the lead in polls. The S&P 500 was +1.84% and Nasdaq +6.26%, as big tech extended its strong bounce back from its March lows.
Infection rates started to rise in the US, causing fears of a second wave. There was an acceleration of cases, hospitalizations and positive tests across the US. About 40% of the US has halted or reversed its reopening. The 4 states that have closed their economies represent 30.3% of the US’s 2019 GDP. This was naturally a concern for investors and the main reason why the US market underperformed other markets globally. Moreover, the average age of new infections dropped from around 55 years of age to about 35 years of age, which was also a material change and the press highlighted that this could have the effect of decreasing hospitalization and death rates by as much as 10x.
Regarding economic factors, governments and central banks have nonetheless announced major economic and financial support (up to $2 trillion in the US) to stabilize the crisis. The Fed kept interest rates steady and the accompanying interest-rate forecast “dots” indicate that rates are likely to remain pinned near zero for at least the next two-and-a-half years.
In terms of employment data, Non-farm employment increased 2.5 million versus -7.5mm surveyed, and the unemployment rate declined from 14.7% in April to 13.3% last month. These numbers reinforce the sense of improvement conveyed by Q2 GDP growth. In addition, Treasury yields applied upward pressure on improving US macro data and supportive comments from Chair Powell.
The V-shaped recovery seems to be confirmed: analysts predict that most EPS losses will be offset in the first quarter of 2020. Some sectors will even show a slight growth compared to 2019.
In terms of sectors, Information Technology outperformed. This sector should continue to outperform due to its exposure to changes in habits related to the pandemic. Consumer Discretionary (for example, Amazon) also outperformed, as economic indicators continued to improve and Covid-19 had a benign impact on e-commerce specifically. On the other hand, Utilities and Energy underperformed.
In terms of styles, Growth continues to outperform. Moreover, the current yield curve is very supportive of this sector. On the other hand, Value underperformed, despite the cyclical rally, till mid-June, because of the fears surrounding the spread of the virus in the US.
Since our last committee, our overweight positions in the healthcare and new technologies sectors have contributed positively to our performance. Despite the relatively cyclical bias during June, companies with positive exposure to the pandemic outperformed, even if the global economic situation remained uncertain. On the other hand, we lost out slightly from our tactical exposure to Financials, despite the cyclical rally mid-June, because of the fears surrounding the spread of the virus.
We are keeping our overweight on Technology, despite relatively high valuations. The upside in the software segment is starting to become limited. However, we still find decent valuations in semiconductors. We are keeping our neutral grade on Industrials, as this sector has limited upside and given the recent outperformance and relatively expensive valuation at current levels. We are keeping our grade on high-quality Banks, as the sector still offers attractive valuations. We are also keeping our overweight on Communication Services, based on attractive valuations, while regulatory constraints are no longer a top priority, given the current economic 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 shall closely monitor the American elections, although the situation is too unclear at this moment to already adapt the portfolio.
Emerging equities: Expectations of normalization of economic activity
Bigger-than-expected policy support, adding to eight EM central banks cutting rates during the month, a better economic recovery than forecasted, the gradual easing of the lockdowns and hopes of an early Covid-19 vaccine made Emerging Markets rise nicely in June, when they outperformed developed markets.
Oil prices were up in June, thanks to a partially restored supply/demand balance and expectations of the normalization of economic activity. Also, other commodities, especially metals, bounced back, with even gold prices holding up amid continuing market uncertainty and the fear of a flare-up (US, Brazil, India, ...) or second wave of Covid-19 infections.
Among regions, Asia was the best performer, mainly thanks to China, as production activity gradually normalized and a V-shaped recovery looked as though it was on track. On-going deteriorating US-China relations added some volatility to Chinese stocks. Korea (South) outperformed, amid North and South Korea tensions, thanks to the recovery of consumer sentiment and the (semiconductor) tech sector, which also supported Taiwan. India, too, rose, despite a worsening Covid-19 trend and resurging India-China border tensions that resulted in the death of 20 Indian soldiers. While the Covid-19 situation worsened, LatAm performed well, thanks to commodity-sensitive heavyweight Brazil. EEMEA rose, too, while Russia was down, partly due to Norilsk Nickel, which suffered a seriously polluting diesel spill in Siberia.
Overall, EM currencies were flat, as the dollar lost ground. Growth turned positive during the month. Among sectors, Healthcare, Communication Services and Technology topped the charts, with Utilities lagging in June. This strong June performance made the second quarter one of the best in years, following a devastating first quarter, historically one of the worst.
We continued to balance our portfolio towards more cyclical stocks, while reducing our growth bias, given the growth/value valuation extreme. This rotation was funded mostly by reducing our Utilities and Consumer Staples exposure to underweight, with both sectors expected to underperform in a risk-on environment.
Within IT, we are positioned more towards hardware than software, on valuation grounds. Within Communication Services, we favour social media and gaming stocks, while being negative on the Telecom industry.
Having tactically increased our exposure to Latin America from Underweight to Neutral last time, we decided to cut our Brazilian underweight in order to add exposure to a typical region with high bombed-out value and cyclical content (financials, energy, commodities).