Equities
 

European equities: reopening of regional economies and strong global goods demand

European equities, supported by the reopening of regional economies and strong global goods demand, closed the month higher. Another strong supporting factor was the acceleration of  vaccination campaigns,  especially in the Eurozone, which is now catching up with the UK and the US.

Although the epidemic is clearly receding in advanced countries, the new delta strain recently caused a surge in new cases in the United Kingdom, where The it has become the dominant strain, pushing the reproduction rate higher. This new variant now accounts for the majority of cases, though the strong vaccination rollout has meant hospitalization rates are low and the pressure on healthcare systems should remain manageable without any new “hard” measures. UK cases now account for close to 70% of cases in the EU5. Despite significant progress, vaccine coverage in advanced countries is still far from sufficient to bring about herd immunity.

Sanitary measures prevented the economy from pursuing its recovery during the winter. However, with the softening of restrictions, mobility has recently surged back. This should support consumption, as emphasized by the latest services PMI and the improving household confidence. In more detail, Euro-area PMI posted a solid gain, propelled by a rebound in services, reaffirming our view that the Euro area will join the rest of the Developed Markets in delivering strong growth into mid-year. Outside of PMIs, Europe’s data remained robust, with the economic sentiment survey continuing its strong upward momentum since February and reaching its highest level since 2000.

We expect GDP to grow by 4.6% in 2021 and therefore be close to trend by year-end. Supply-side constraints are still impairing manufacturing production but the rebound in global growth should support activity. Pent-up demand and easing social distancing measures should fuel consumption over the coming months, all the more so since household confidence has sharply improved. However, bringing the economy back to full employment will probably take more time.

The Own Resources Decision has now been ratified by all Member States, opening the way to the first payments to governments. However, future payments will be conditional upon the fulfilment of a group of milestones which will test EU supervision ability as well as Member states’ absorption capacity.

Inflation has increased but a sustained acceleration seems unlikely. Also, a lot of disparities exist among Euro-area members.

The ECB will remain accommodative to preserving favourable financing conditions; its strategic review will likely lead to a more symmetrical inflation target.

In terms of earnings, European markets are positively revising their estimates for July, especially on cyclical stocks.

Regarding equity flows, we observed significant inflows in Q2, while mainly in Q1 for the US markets, but volumes are starting to calm down.

Based on our P/B vs ROE matrix, some sectors (like Financials and Utilities) remain attractive, while Consumer Staples, which was lagging behind Consumer Discretionary, has started to catch up. IT, for its part, continues along its “all-time high” path.

In terms of sectors, HealthCare was the best performer, especially the growth stock of this segment. A moderation in long-term government yields led to a resurgence of growth stocks, and biotechnology and Healthcare equipment (among others) fit well into this picture. On the other hand, Financials underperformed, in line with the evolution of interest rates.

Interest rates slightly decreased again, and markets are expected to adopt a “wait-and-see” attitude for 2021 and not anticipate any concrete rate changes before 2022. However, 2H 2021 should  offer some short-term opportunities. For example, we should observe opportunities on value stocks when both summer tourism flows and the delta variant generate doubts in the market. That said, our central scenario remains that vaccine injections will continue to grow and that severe forms of the delta COVID will remain under control. This could then reassure markets and make value stocks rise again at the end of the year. More generally, investors, looking ahead to 2022, should rely more on fundamentals than on market sentiment.

As a result, all our grades remain unchanged, as we await more short-term visibility.

We have kept our grades on Financials and Banks at +1. Following the strong YTD rally, and since early November, the risk-reward ratio is now less interesting but we have kept our grade, given the high probability of a further positive evolution of long-term rates. We could become more cautious on Banks by the end of the year, as we expect provisions to increase in 2022.

We have kept our negative grade on Automobile & components and Consumer Discretionary. The mega-trends in the sector (electrification, autonomous driving, etc.) will require OEMs to make large investments, which will weigh on their margins.

We have kept our -1 on Utilities, following the strong YTD underperformance of the sector. We remain underweight but to a lesser extent, as Biden's ESG plan is adding demand in terms of renewable capacity. In addition, the Spanish government has a new taxation project on Utilities.

We have kept our +2 on Consumer Staples (Food & Beverage and Household & Personal Products) because of its very attractive valuation and low risk level. This sector is a high-quality and long-term outperforming player. Finally, the sector is very under-owned versus its benchmark and its historic levels.

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US equities: more fiscal stimulus

US equity markets closed the month higher. The outperformance of the US can be put down to the rebound of growth stocks and the prospect of more fiscal stimulus, as Joe Biden reached a bipartisan deal to boost infrastructure-spending by USD 600 billion.

In the US, the epidemic seemed to be getting under control. However, the delta variant has become the dominant strain, pushing up the reproduction rate. More contagious strains increase the share of the vaccinated population needed to prevent exponential virus transmission. Despite significant progress, vaccine coverage in advanced countries is still far from sufficient to bring about herd immunity. Unless the vaccination pace accelerates in the United States, a new wave of infections is the most likely scenario. However, the pressure on healthcare systems should remain manageable without any new “hard” measures.

Slowing growth momentum: in June, manufacturing activity was still on a strong footing but companies and suppliers continued to struggle to meet the rising demand. As a result, there were some fears that macro data were peaking, particularly in the US, where the flash composite PMI for June declined (led by a decline in services from an all-time high of 70.4).

By the end of Q1, the economy had recovered most of the ground lost during the pandemic. Residential investment growth should now be curbed while business investment should continue to support growth Accumulated excess savings in the hands of high income households should support the recovery in services consumption. For 2021-22, only part of the “under-consumption” savings are expected to be spent.

A $1.2 trillion bipartisan infrastructure plan is now under discussion in Congress. Still, many parts of Biden’s agenda have been excluded from the bipartisan deal, including broader action on climate change and “human infrastructure” measures like an expanded child tax credit and care for the elderly.

Inflation has accelerated but, without any self-reinforcing mechanism at play, this should prove transitory (although longer-lasting than some are expecting). Labour mismatches emerged in different sectors, creating some tensions on wages, but, overall, these pressures are still far from extreme and maximum employment remains distant.

Although the Fed will wait for substantial progress to materialize in the labour market before tightening its policy, it will prepare the market for tapering. While delivering no change in policy and little change in its economic outlook beyond this year, the FOMC shifted its guidance in a hawkish direction at its June meeting. The “talking-about-tapering” balance-sheet policy that began at the meeting was expected. However, the median forecast for the start of normalization moved more forcefully forward, with seven committee members now projecting rate hikes next year. This shift largely reflects a fading of the pandemic-related risks that likely kept most Fed officials cautious through the March meeting.

We expect GDP to grow by 6.5% in 2021 and 4% in 2022. Our scenario sees most of the population vaccinated by Summer 2021, allowing a gradual end to social distancing. Fiscal measures support the recovery.

Still-solid earnings momentum: All in all, the consensus EPS forecast for the US does not look overly pessimistic to us. Based on GDP growth, we could see some improvement. But one should not expect a rebound of the same magnitude as that anticipated for GDP, because the fall in earnings was much more contained for S&P companies. Our forecast (based on our model) anticipates a slightly stronger improvement in EPS than the consensus but not by a wide margin (~5% at end of 2022, which might not be statistically significant). It also anticipates a below-12 month FW EPS.

US remains the most expensive region with an average 12M forward P/E of 21.9 vs. 18.7 for the World and 17.1 for EMU.

Based on our ROE vs. P/B matrix, sectors such as Financials, Energy, Utilities, Materials, Healthcare and Consumer Staples are attractive. On the other hand, cyclical sectors such as Consumer Discretionary and Industrials seem particularly expensive.

In terms of sectors, Information Technology and Healthcare were the best performers. A moderation in long-term government yields (in part because of the rapid spread of the delta variant of the COVID-19 virus) led to a resurgence of growth stocks, and IT, Biotechnology, Healthcare Equipment (among others) fit well into this picture. On the other hand, Financials and Materials were the worst performers.

In our view, 2H 2021 should offer some short-term opportunities. For example, we should observe opportunities on value stocks, when both summer tourism flows and the delta variant generate doubts in the market. However, our central scenario remains that vaccine injections will continue to grow and that severe forms of the delta COVID will remain under control. This could then reassure markets and make value stocks rise again at the end of the year. More generally, investors, looking ahead to 2022, should rely more on fundamentals than on market sentiment.

As a result, all our grades remain unchanged as we await more short-term visibility.

We remain Neutral Material. Bad risk/reward, high valuations and commodity prices are now too high, in our view, and most commodities are now above pre-pandemic levels.

We are keeping our strong overweight on Banks.

We are keeping our neutral grade on IT, as it is still too early to increase our exposure. However, this is  a purely tactical move, as we remain, medium and long term, very bullish, but rising 10Y interest rates have convinced us to lower our rating in the short term. However, it’s a real Neutral, far removed from “Sell”, as earnings were good and, again, industry drivers are great (innovation, IT infrastructure, 5G, semiconductors).

We are increasing our neutral grade on Consumer Staples from -1 to neutral, as the sector has underperformed on its 10Y move  and valuations are too low to remain UW.

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Emerging Markets: under pressure with the delta variant

Emerging Market equities ended flat for the month (June -0.1%, YTD +6.5% USD returns), underperforming Developed Market equities by 1.5%. With the Fed hinting at discussing tapering at forthcoming meetings and possible early policy normalization, the dollar gained, while yields came down, factoring in the transitory nature of inflation. In the latter part of the month, however, the US bipartisan infrastructure bill spurred risk appetite and Emerging Market equities gained ground. Emerging Market currencies broadly lost ground against a strengthening dollar index (+2.9%).

Amongst Emerging Markets, heavyweights China (-0.4%) and Taiwan (+0.4%) were broadly flat for the month, with declining yields helping tech and growth names. On the one hand, commodities came down from the highs of May as China clamped down on commodity prices. Delta variant risk weighed on ASEAN markets, where the vaccination pace continues to lag.

LatAm outperformed during the month (June +2.4%), with the commodity-heavy markets gaining ground on the back of rising oil prices (Brent US$75.12/bbl). Brazil (+4.8%) was amongst the best markets during the month with new tax reforms and expectations of a faster reopening

All our grades remain unchanged.

China “losing momentum”: (1) Flat-lining growth (2) Tight credit conditions (3) Intervention on commodity markets to control manufacturing inflation (4) Ongoing tech crackdown.  No surprises so far this year: virus contained, economy continuing to open up, no evidence of inflation pass-through. No big news in terms of US-China trade. Downward revisions to 2021 GDP growth: (1) weakness in consumer (durable goods), (2) infrastructure investment slowdown – reduced fiscal support (3) soft credit demand (4) CNY appreciation (strong exports and fiscal discipline = reserve currency – “long march”), (5) 1.2bn COVID shots administered. Because of the very strong relationship between China credit impulse and cyclical stocks, portfolio rebalancing is on the margin. Limited visibility on policy but, as growth momentum eases, it could become more supportive in 2H21. STOCK-PICKING MARKET.

We are keeping our +1 on Mexico, as the ongoing value run and US recovery should benefit Mexico – cyclicals versus ESG considerations. Incumbent losing qualified majority (2/3) in Congress (keeps single majority) reduced policy uncertainty.

We confirm our upgrade to Emerging Europe from -1 to neutral on growth recovery – vaccinations/COVID – Europe – Commodities. However, stock selection remains key.

We are keeping our grade on Brazil, high leverage on commodities, value and cyclical stocks; stock selection / ESG an issue. GDP growth being upgraded as economy reopens and vaccinations pick up (100m shots administered). BRL firmer on CB action and higher oil prices. Reforms optional.

We remain Neutral on ASEAN, COVID also impacting re-opening in ASEAN, region not fully profiting from global growth and value recovery. Stock selection.

We remain Neutral India, after the recent strong market recovery following the weakness on serious COVID resurgence, due to rich valuations and currency risk – Market flat since our upgrade to Neutral.

We remain Neutral Taiwan, structural growth stories, deep cyclical tech geo-political risks, though, prevent us from going OW.

We remain overweight (+1) on Materials, on expected strong long-term supply/demand support  -  but some ST profit-taking after strong performance not excluded. Trimming winners.

We remain neutral Healthcare. However, long term positive + potential for upgrade after period of weakness.

We remain overweight Semiconductors & Equipment, based on strong positive supply/demand momentum  -  but some ST profit-taking after strong performance not excluded.

Finally, we continued to keep a balanced portfolio, combining value/cyclical and ‘opening-up’ exposure with quality growth stocks and sectors (technology, healthcare, CD) somewhat protecting the portfolio from profit-taking in more interest-rate-sensitive and longer-duration growth stocks, which came under selling pressure towards the end of the month. As a result, in terms of styles, we are more balanced between growth/value and cyclicals, and are reducing momentum bias as a funding source, despite our longer-term positive view.

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