From deep value to ‘value with a future’

Parts of the world are still wrangling with Covid-19 and lockdowns, and sometime in the second quarter of 2021, the market is likely to start anticipating the dreaded t-word (‘t’ for ‘tapering’). Yet countries are learning to co-exist with a pandemic, the US has sprung on us a USD 1.9 trillion stimulus package, and the Biden administration is working on USD 2.3 trillion in infrastructure investments.

While the fiscal bonanza will impact the US first, the rest of the world will also benefit from its repercussions for global activity. Let’s not forget that the strong recovery expected in global trade is one of the reasons why the International Monetary Fund has lifted its 2021 China GDP growth estimate to an impressive 8.4%.

Clearly, a sizzling economy means higher inflation, but we are still far from levels that would reverse the course of the economic recovery. We are, actually, in the sweet spot for equity markets, as these generally benefit from inflation rising from low levels: historically, the S&P 500 Index has shown outperformance most frequently when CPI was between 1% and 3%.

Both our DM and EM teams have remained positive on their respective equity markets. The only factor that we downgraded, from positive to neutral, is the sentiment factor in EM. We have seen unprecedented investment flows into EM of more than USD 120 billion since October 2020, and we expect inflows to continue but at a slower pace.

We expect further rotation from the Covid-beneficiary and Covid-defensive stocks to those that will benefit from the economic normalization. This means that value has further outperformance ahead – as long as the economic outlook continues to improve. However, we expect an increased degree of selectivity among investors in their choice of stocks.

Investors will start to look for stocks with the ability to deliver on their perceived value, showing better earnings potential in a normalization of the macroeconomic backdrop. Therefore, after the first wave of value investing boosted all cheap stocks, we expect the second wave to focus on what we call ‘value with a future’, i.e. companies with inexpensive valuations that do not discount their sustained earnings growth ahead.

Our largest overweight across portfolios remains North Asia, although we have taken some profit in China, where we expect market momentum to slow down. Credit growth in the country has peaked, and this is likely to lead earnings to peak. Moreover, around 40% of the weight of the MSCI China Index is in internet-related stocks. This affects the index in the rotation away from expensive and often loss-making digital stocks.

That said, the main change from a country standpoint in our Global Equity portfolios occurred in DM, as we have added to US equities at the expense of Europe. The US is more advanced in fighting the pandemic, and has significantly stepped up fiscal stimulus. We believe that a recovery in the US will be much stronger than in Europe for the foreseeable future, and that US equities will benefit.