European equities: Sharp rotation from cyclicals to defensives.
European equities dropped throughout August, alongside particular weakness in the UK. We saw
a sharp rotation from cyclicals to defensives as global bond yields collapsed everywhere, with a further switch out of “value” stocks, in particular banks.
In recent years, growth (style) – driven by strong forward earnings growth and profit margins – has outperformed value. However, as, in our view, the growth style has become too expensive, we are creating pockets of “value” in our portfolios to protect our funds against an eventual market reversal. The Financials, Technology and Energy sectors underperformed the market in August while Healthcare and Utilities performed well.
Any positive outcome to the Brexit deal and US-China trade talks could even be supportive in the short term.
We reduced our exposure to the Luxury, Insurance, Food & Beverages and HPC sectors. Valuations on luxury are too high, in our view, as trade tensions between China and the US have impacted tourism – a strong catalyst for this sector. We reduced our exposure to the insurance sector, which is more expensive than the European market and – definitely – banks. The Food & Beverage and HPC sectors are also, in our view, overvalued.
US equities: The S&P 500 remains close to its highest level.
Global stock markets suffered in August, with the MSCI World (-2%) the S&P 500 (-1.81%) and the Stoxx 600 (-1.63%) all declining. Trump announced he would impose a 10% tariff on the remaining $300bn of imports from China on 1 September. China responded by halting purchases of US agricultural products in a context of a weakening yuan.
Even though US equities dropped in August, mainly due to the trade war between the USA and China, the S&P 500 is still close to its highest level. US 12M forward P/E is above average and has risen more than global markets despite weaker-than-expected global growth. EPS growth remains weak for the year 2019 and only 30% of earnings have a positive revision. Despite the current market environment, US cyclical stocks – driven mainly by strong IT growth and a resilient US market – were still resilient versus defensive equities. Small caps have underperformed the market, with the Business Confidence index falling sharply. The Consumer Discretionary and Utilities sectors performed well last month. Although the earnings outlook for 2020 seems to be attractive (around 10%), it assumes a relaxation of the global trade war.
We increased our Information Technology exposure, mainly from semiconductors, as companies are rather optimistic about the coming months. We are slightly cautious on Industrials, as they might deliver a poor earnings season. US Small & Mid-caps suffered amid low liquidity, visibility and business confidence. We remain positive on Healthcare, a resilient sector in the current market environment.
Emerging equities: a month of sell-offs.
Emerging Markets declined once again, the seventh consecutive month of underperformance.
Global risk-off sentiment, driven by increasing US recession risks and the US-China trade war, lost Emerging Markets 5.1% in August. In Asia, the US-China trade re-escalation, with China retaliating against US President Trump's increased tariffs, weakened market sentiment.
The correction in China was exacerbated by the rising political tensions and demonstrations in Hong Kong, as well as a further depreciation of the Yuan. In India, the RBI’s attempts to boost weak economic growth with a rate cut and fiscal stimulus did not prevent the Indian equity market losing ground.
Korea was hit by trade frictions with Japan, weakening exports and pressuring earnings. In EEMEA, the weakness in the oil price hit both Russia and Saudi Arabia while, in LatAm, profit-taking and a falling Real hit Brazil, partly due to the currency and market crash that hit Argentina following the defeat of the incumbent president in the primary elections.
Risk-off sentiment supported the price of precious materials, while the price of commodities (Brent Crude, copper, ...) plunged. Sector-wise, all saw a negative month, with Real Estate and Financials the worst performers.
We remain positive about ASEAN as a counterweight to our cautious stance in China/South Korea –countries typically less dependent on global trade given their relatively closed economies. We also remain positive on Brazilian equities, a safer LatAm market than Argentina, which suffered the most following a shock loss for the President in the primary elections. We slightly increased our stake in Russia, based on a positive risk-reward. We also increased our positions in Consumer Staples, Consumer Discretionary and Information Technology while reducing our stake in Industrials. The deal/no deal situation and hawkish/dovish Fed remain uncertain and we need to adjust our portfolios accordingly.