Beat the headline

Beat the headline

25-01-2021 | Column
The events that have unraveled over the last quarter have added support to our constructive stance on global equities. We have had the approval of high-efficacy vaccines, and a clear outcome from the US elections. The incoming US administration, now strengthened by a win of the Senate de facto majority, is set to unleash further stimulus. Add to this a continuation of the easing bias of the largest central banks, and equity markets remain well underpinned.
  • Fabiana Fedeli
    Global Head of Fundamental Equities

Speed read

  • It’s not growth vs value, it’s headline vs fundamentals
  • The global economy is on the mend: we upgrade the earnings factor
  • Time to dig deeper: the enablers and the parallel stories

The biggest risk, at this point, is the emergence of vaccine-resistant new strains of the virus

Of course, let’s not kid ourselves: none of this is will imply a straightforward path ahead. First, the distribution of vaccines has had a slow start in most countries. Second, the win of the two Georgia Senate seats on 5 January 2021 implies a de facto ‘blue’ majority, given the tie-break vote of Vice President Harris. Yet, this does not offer free reign to the Biden administration on all of its planned policies, as the administration’s legislative proposals could be blocked in the Senate by filibuster.

While we recognize the hurdles ahead, we believe that neither of the two issues are reasons enough to change our supportive stance on global equities. They could, however, cause occasional negative market reaction. As we have maintained for the last few quarters, the Covid-19 outbreak and its impact on the economic recovery remain the key drivers behind equity markets.

The amount of resources put in by governments and the healthcare community to increase the vaccination rates worldwide is unprecedented. This bodes well for rapid improvement, although certainly not at light speed. The biggest risk, at this point, is the emergence of vaccine-resistant new strains of the virus. Thus far, this does not appear to be the case.

US elections: we have moved to Goldilocks territory

The result of the Georgia run-offs has changed the investment playground for equity investors, arguably for the better. Within the limits and implications of potential filibuster, large parts of the Biden administration’s agenda can be achieved with a slim majority in Congress. This includes the approval of policymakers, as well as more stimulus, environmental policies and changes to the US healthcare system than we would have had with a divided Congress.

Of course, the amount of funding for stimulus, climate and healthcare initiatives will be limited by the need for a budget reconciliation process. This is not a bad outcome for equity markets, as it will actually provide a silver lining for US investors concerned by the more left-leaning potential policies of a Democratic administration. From this point of view, we have moved to a ‘Goldilocks’ scenario. Not too hot, not too cold.

There are two areas within equities, however, where we could see a tangible negative impact. First and foremost, with the approval of policymakers being only dependent on a simple Senate majority and not affected by filibuster, we are likely to see nominations that will bring more regulatory scrutiny on the financial sector, big data, and high environmental impact industries. For the financial industry in particular, the negative effect of higher scrutiny could be offset by the benefits of an economic rebound, but it will all depend on degrees of magnitude.

The other area of potentially negative impact will be healthcare. Given the narrow Congress majority, the outcome of the US elections is still broadly positive overall for the healthcare sector, with radical reform likely to be off the agenda. However, within healthcare subsectors, the impact will be different.

For example, life science tools companies are likely to benefit from increased funding to support the US academic research base, particularly given the on-going pandemic. Conversely, we could see setbacks in the sentiment recovery for the pharmaceutical industry, as market anticipation of drug price reform has now been raised. In reality, such reform is still likely to be relatively limited in scope, given the slim Senate majority, and also pushed back in time.

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The problem with valuations is that they are averages

While average valuations have risen across equity markets, we do not believe we are at the point yet where they will put a damper on global equites upside. Not all markets are richly valued, and certainly not all stocks. The exceptional polarization that we have seen in stock performances over the last three quarters still allows investors to find attractive stocks at more reasonable valuations.

The exceptional polarization that we have seen in stock performances over the last three quarters still allows investors to find attractive stocks at more reasonable valuations

On a relative basis, we find more attractive investment opportunities in North Asia and Europe than in the US. Importantly, valuations are not sufficient to determine the attractiveness of a market. Relative earnings growth will continue to be the real discriminant, and this will be the key variable to monitor.

The Headline Effect

The polarization in market performance over the last year brings me to what I believe could become one of the most remarkable legacies of 2020. Last year was a year of extremes. The five largest stocks in the S&P 500 Index returned 64.5% versus an average return of 9.7% for the remaining 495 names. Last year also saw the highest number of daily moves over 1% and 2% in ten years, for the S&P 500 Index.

I cannot help but think that this has something to do with another record: retail investors’ participation in equities trading. According to Bloomberg Intelligence, individual stock trading through June 2020 was at a 10-year high, with retail trades estimated at 19.5% of all US order flow, up from 10.1% in 2010 and 14.9% in 2019. And this was not a US-only phenomenon. Retail trading accounts have been rising across the world.

While I do not have any clear proof that increased retail investor participation is a key driver behind the divergences in market behavior in 2020, what clearly appears in the market is a certain ‘headline effect’. Stocks that have a well-recognized brand, or a well-recognized story have seen unprecedented buying relative to the rest of the market.

This leaves an opportunity for investors that are willing to go the extra mile in researching stocks. For all the well-known new energy and new vehicle names, for all the well-known digital giants, there is a number of stocks that I like to call enablers, which are part of the chain of products or services which support those well-known players, as well as stocks that will be driven by those same trends, as they may make products that are not as glitzy, but that will be growing in parallel. That is where the ‘value’ is. Many of these stocks are still trading at reasonable valuations.

Implications for our portfolios

Both our Developed Markets and Emerging Markets teams have turned more positive on their respective equity markets. The common denominator is the upgrade of the earnings factor, as earnings revisions have significantly improved across developed and emerging markets and are now positive in both regions. Importantly, the earnings recovery appears broad based, as earnings revisions are improving across most sectors.

Earnings revisions have significantly improved across developed and emerging markets and are now positive in both regions

As vaccinations and better therapies help mitigate the extent of the Covid-driven economic lockdown, and activity continues to normalize, we expect further rotation from the Covid-beneficiary and Covid-defensive countries and stocks, toward countries and stocks that will benefit from the economic normalization. In the US, such rotation will be further supported by additional stimulus.

We are not concerned about the recent increase in US long-term yields, as these came on the back of the stimulus expectations and we don’t expect inflation to rise to levels that can stifle equity markets for the remainder of 2021. We continue to caution that selection remains key, as not all companies will be able to recover from the effects of extended lockdowns.

Overall, from a regional perspective we continue to favor emerging markets, which is our largest overweight position in our Global portfolios, followed by Europe. We find a few interesting opportunities in Japan, particularly in the technology sector. Within emerging markets, we continue to favor North Asia (China, Taiwan and South Korea).

In emerging markets, initial signs of Covid-19 deceleration and of a turnaround in economic momentum are starting to appear outside of North Asia. These will eventually warrant broadening our emerging markets positioning, and, on this basis, our Emerging Markets portfolios have increased their position in India. But these are relatively small moves and we would need to see further progress before we significantly increase our relative positioning outside of North Asia.

From a sector standpoint, our largest global overweight position is in technology, although we have cut further our positioning in the tech savvy high flyers in the US and Asia, as comparison bases are destined to become more challenging in the next two quarters and regulatory scrutiny is here to stay.

We have also taken additional profit from the Communications Services sector. We find more opportunities in Industrials, Consumer Discretionary, Specialty Materials and Healthcare, and have selectively added to Financials in the US and in emerging markets. Within healthcare, we have added to life science tools.

Last but not least, we continue to like sustainability as a theme. Besides the European ‘Green Deal’ and an increasing number of Asian markets pledging carbon neutrality by 2050-2060, the Biden administration with a united Congress should also trigger more investment in this area in the US.

The main risks to our outlook could be new virus outbreaks, or slower than expected vaccination campaigns, which we will continue to monitor.

Above all, we still find compelling opportunities in a market where polarized positioning was the name of the game in 2020. The jury is still out on whether this is due to increased retail participation. In the meantime, there is still plenty of upside potential for active investors willing to look beyond the headlines.

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