Equities monthly - February

The EQUITIES MONTHLY provides an overview of our investment team’s views and positioning in each of the key markets. Each of our portfolio managers has discretion over the positioning and holdings of their portfolios. Given this portfolio manager discretion, there may at times be differences between strategies applied within a fund and the views shared below.

Views from the Global Trading Desks

Global Themes

Markets were volatile in January, driven by rising geopolitical tensions and coronavirus outbreak and concerns over their impact on the global economy. Global growth indicators were under pressure with the broad commodity complex trading at a 2-month low and yields across the entire Treasury curve sharply lower post the initial peak in early January. US markets saw gains (Nasdaq +2.96%; S&P 500 -0.16%), Europe ended quite mixed (Stoxx50 -2.78%, DAX -2.02%, FTSEMIB -1.15%, FTSE100 -3.40%, SMI +0.10%) and Asia ended in the red prior to the Chinese New Year (CNY) (Hang Seng -6.66%, SHCOMP -2.41% Nikkei -1.91%). Volatility stood at a 4-month high with the VIX seeing a steep jump since mid-January. We expect near term volatility to remain.

Novel Coronavirus Outbreak Leads to Risk-Off Environment

Markets experienced sharp rotations, and the Value trade took a sharp leg lower alongside Cyclicals and commodity prices (Brent -11.88%), reversing most of their gains from the last four months. There were sharp moves in factor performance where growth spiked as bond yields dropped. Utilities (+7.89%), Real Estate (+1.67%) and Health care (+1.64%) were the best performing sectors. Defensive sectors outperformed cyclicals as bond yields collapsed in the risk-off environment. Autos (-9.77%), Basic Resources (-7.55%) and Oil & Gas (-7.44%) were the worst performing sectors as commodity prices collapsed with iron ore, copper and crude oil particularly weak, dragged down by the coronavirus reports and despite positive economic data from China. Autos underperformed (as part of the Value trade) led by heavyweight Daimler, BMW and Volkswagen in the weakness. In the UK, Homebuilders were +9.31% while Banks fell -8.74%.

The main focus of the month was the coronavirus. The Chinese New Year holiday is usually the golden season for consumer spending, and the fear factor and stay-home control measures have almost paralyzed sectors such as tourism, transportation and consumer discretionary to name a few. Asia is set to see the worst spill overs from the virus due to its dependence on Chinese demand and tourists, e.g. Hotel Shilla in Korea had to shut down its flagship property in downtown Seoul.

Emerging Market ETFs See Outflows…But Safe Haven Assets Were in Demand

The fallout from the coronavirus outbreak put an end to a 16-week streak of flows into emerging-market exchange-traded funds that had reached almost USD (?) $19 billion. Investors withdrew USD (?) $2.52 billion from US-listed emerging-market ETFs in the week ending 31 January. That was the first net weekly outflow since early October and the largest since mid-August.

The virus’ impact has spread into the commodities: Brent was down -11.88% and WTI fell -15.56% stoking concerns that demand for transportation fuels will shrink. Precious metal prices saw an increase with Gold rising by +4.74%, Silver +1.07% and Palladium +17.59%. Gold jumped for a second straight month, trading near the highest since 2013 as concerns about the fast-spreading coronavirus supported demand for haven assets.

Better-Than-Expected Q4 Earnings In US; Japan Mixed

In the US Q4 earnings are generally coming in better than consensus, particularly on the larger cap / high profile stocks. As at the end of January, 225 S&P companies had reported 4Q results (61% of total cap). 47% of companies reporting have beaten earnings estimates (in line with the historical average) and 14% have missed estimates (also in line with history). The average EPS surprise has been 3.7%, below the 5.1% historical average. In Japan 43% of companies had reported results, however the earnings thus far do not appear to be that strong, the misses have come from Basic Materials, Consumer Services and Financials.

Global

Monthly review

Global equities declined in January (in US dollar terms) as the spread of coronavirus reduced investors’ appetite for risk. Concerns over the virus outbreak checked the stock market optimism that followed the signing of a phase one trade deal between the US and China. Markets were also less worried by the brief flare-up in tensions between the US and Iran, which de-escalated swiftly. Pre-coronavirus economic data across regions continued to show signs of improvement (with PMIs improving across a number of economies). With major central banks set to remain accommodative in the coming year, near-term recession fears appeared to be subsiding.

US shares were largely flat, with energy stocks hard-hit following a cratering of demand in China. The eurozone, whose economy is closely linked to Chinese demand, saw stocks decline on similar worries. The weakest sectors included energy, materials and consumer discretionary, the latter being particularly vulnerable to travel and movement restrictions in and out of China, which are likely to curtail demand for luxury European products. Japanese and Emerging Market shares succumbed to similar pressures.  From a news flow perspective, the UK remained in the limelight in a month that saw it formally exit the EU. Uncertainty over its future relationship is likely to persist through 2020, as the parties negotiate trade terms.

Spotlight - Global PM View On Coronavirus

Given the importance of China in the global economy and the dominant theme in the market in January i.e. coronavirus, the big question we are keeping an eye on is China’s response. Will the Chinese government give up its deleveraging/financial stabilisation program and launch an all-out stimulus? So far, their response (including their latest monetary easing) has been very measured. However, if this happens, it will add to the broader global monetary easing, which would be very financial market (both bond and equity) friendly. However, the long-term impact could be negative as it could imply that they are moving away from their long-term stability plans focused on deleveraging.

We have been talking to companies on the impact of this disease outbreak and the first order impacts are being well discounted. There is limited business happening in China and this is weighing on growth for this quarter for sure, but for now the market is looking through the downside as it is making the assumption that a) this will be short-lived and b) the snap back impact will be positive for economic data. While we believe there could be a hit on global earnings from lost business activity in China due to the virus, there has been no significant overreaction in global markets that would prompt a big change in our portfolios at this stage.

US

Monthly review

US equities succumbed to coronavirus jitters after recovering from an early risk-off move on Mideast tensions after the US and Iran limited their (military) dispute. Markets have focused on the impact of business and trade disruptions resulting from the coronavirus pandemic, including measures governments might take to limit international travel and trade. Elsewhere, market reaction was generally muted to the US-China trade deal signed on 15 January, with expectations having already been baked in. Nevertheless, the move compels both sides to stop adding to the economic damage they have sustained from the imposition of tariffs - a significant relief for the market. US politics (impeachment hearings) went by largely unnoticed, as the consensus view still sees no disorderly outcome. Meanwhile, the US Federal Reserve (Fed) maintained the Fed funds rate in a band of 1.50% to 1.75% in a unanimous vote, indicating that the bar is high for any change ahead. Overall, energy and materials stocks fell the most - oil prices rose initially, but fell to close the month at USD 51, as the market was able to trade through the Mideast issue, while maintaining optimism. The demand for commodities is sensitive to the lockdown measures taken by China to resolve the virus situation. Utilities and information technology stocks were immune to any contagion effect and continued their uptrend, while headwinds for value style indices persisted due to the perceived back-step in incremental business activity. 

Economic data was broadly positive - the initial estimate for fourth quarter GDP came in at a moderate 2.1%. The ISM manufacturing Purchasing Managers’ Index (PMI) registered at 50.9, a 310 bps increase from December. Retail sales were strong in December but spending in the fourth quarter was dampened by a downward revision in prior month data. Meanwhile, lower borrowing costs are boosting the housing market as housing data continues to firm.

Spotlight - US Macro Outlook Remains Positive

US equities have by and large weathered the slowdown in economic growth and trade rifts amid tariff wars these past couple of years. As some of these uncertainties fade away, particularly in light of the US-China trade deal and France backing off its planned unilateral imposition of a digital tax that was set to negatively impact technology companies in the US, there is now a reduced chance of international disputes sparking equity market volatility. Risk appetite has further increased, with the expected improvement in earnings growth from hereon.

The Q1 earnings season has seen a positive start. US corporate return on invested capital is well above borrowing costs, allowing firms to borrow and invest profitably. These positive drivers should spread, causing a better outlook for manufacturing and corporate capital spending. Improving liquidity conditions also point towards a constructive outlook for risk assets. US equity market volatility associated with the coronavirus outbreak being deemed a global emergency is unlikely to persist for a lengthy period, barring any significant change in the news flow around the virus itself. China has taken enormous steps to contain the disease, vastly shifting resources and spending. That said, there are caveats in the form of other moving parts - consumer strength has been vital to economic health. Any signs for a possible contamination through moderation in other business cycle indicators will have to be closely monitored. Meanwhile, liquidity is under threat from the decline of globalisation. The frictionless flow of capital around the world is susceptible to increasing barriers, such as those resulting from trade disputes. Threats from possible geopolitical risks will also need to be watched closely. The maturity of this long bull market (which hasn’t been a typical one) could potentially be tested as the year unfolds. Nonetheless, US markets should continue to rise if economic data remains supportive. In a global context, the US is favoured by investors for being less exposed to cyclical sectors relative to many other (particularly emerging) markets.

Europe

Monthly review

After an encouraging performance in 2019, European equity markets fell in January. Despite the month starting on a positive note helped by the optimism around the signing of a phase one trade deal between the US and China, these gains were more than offset later in the month over concerns on the coronavirus outbreak. Whilst US-Sino trade tensions appear to have cooled, the market’s confidence has been knocked by renewed concern of trade tensions between the US and the European Union (EU). President Trump has signalled retaliatory tariffs on European car exports if the EU imposes a new digital services tax on US technology companies. Whilst the UK has formally exited the EU as of 31 January, uncertainty over the future relationship is likely to persist through 2020 as the parties negotiate trade terms. In the risk-off environment, cyclicals underperformed defensives. The sectors most notably impacted were energy, materials and consumer discretionary (mainly autos and luxury goods companies). Utilities, health care, and real estate shares outperformed the broader market.

GDP growth in the eurozone remains positive but muted, at 0.1% in the final quarter of 2019. The flash composite PMI remained unchanged in January compared to the previous month’s reading of 50.9. Encouragingly, the manufacturing side of the economy showed some signs of recovery. The sector continued to contract, but at its slowest rate since April 2019, as output, new orders and purchasing all improved. Meanwhile, activity in the services sector rose, albeit at a slightly weaker pace than seen in December. Inflation in the region rose to 1.4% in January, whilst the unemployment rate fell to 7.4% in December, the lowest level since May 2008.

Spotlight - A comeback decade for UK Equities?

The decade of the 2010s was not the most encouraging for UK equities, as they have underperformed global markets generally over the past 10 years, while GDP growth has also largely disappointed. Consequently, there is none of the stretched valuations you see in other markets, with UK equities on most measures being fairly valued to undervalued versus their own history and under-valued relative to the rest of the world. Some of this is, of course, deserved due to the events of the past five years, and the UK has been a major underweight in the portfolios of most global asset managers. On most long-term relative measures, there is indeed a long way to make up for UK equities. So, at least from a valuation and sentiment perspective, the UK has its advantages. 

With the elections out of the way, the UK has the potential to be an island of stability in a world where there is likely to be significant political upheaval going forward. However, what remains unclear is the policies that Prime Minister Boris Johnson will follow - will he follow the hard Brexit path or be a little bit more pragmatic. Keeping this in mind, it would be prudent to keep an eye on the government’s plans, such as their fiscal priorities (infrastructure & education should be top of the list), plans on housing, central bank policy, signs of any improvement in private sector capex, household sentiment and consumer spending.

The things we will be monitoring to get a sense of whether the UK is on the right path include: the government’s priorities in the annual budget on March 11 and whether austerity is now over; plans on housing to address affordability; Bank of England policy is likely to be accommodative as long as inflation is not an issue and the fiscal policy lever is not unduly pressed; private sector capex now the Brexit overhang has passed; companies’ willingness to spend once they have clarity on the future path of trade negotiations. Early data shows that consumer confidence is trending up post the elections and policies of the government on housing and taxation as well as fiscal stimulus could provide a boost. Marginal changes in all of these components with the attendant catch-up effect of three years of stasis could collaboratively be quite positive for the UK economy.

Japan

Monthly review

The Japanese market fell in January after four months of gains as concerns over the spread of the deadly novel coronavirus outbreak in China weakened risk sentiment. Equities started the month on a positive note amid receding concerns over an escalation of US-Iran tensions, following the killing of an Iranian general by the US. A weaker yen also supported stock prices early in the month. However, following gains in the previous months, investors took profits to lock-in gains. Increasingly risk-averse investors rotated away from stocks that had performed strongly in previous months and focussed on defensives. At a sector level, marine transportation, mining and non-ferrous metals were the biggest decliners, as these stocks could be impacted by the novel coronavirus outbreak. Real estate, securities, other finance and pharmaceuticals were among the few sectors to record gains. From a style perspective, value stocks underperformed growth names, while large-caps performed relatively better than their smaller peers, although all these segments recorded negative returns.

In economic developments, Japan's exports fell in December from a year earlier, but shipments to China rose for the first time in 10 months. Meanwhile, manufacturing activity shrank for a ninth month in January as output and new orders contracted. Nevertheless, the decline was at the slowest pace in five months, possibly reflecting easing US-China trade tensions and alleviating fears of a recession. The Jibun Bank final manufacturing Purchasing Managers’ Index (PMI) edged up to a seasonally-adjusted 48.8 from December’s final 48.4 reading (announced in early February), but stayed below the 50.0 threshold that separates contraction from expansion for a ninth month.

Spotlight - Coronavirus Clouds Japanese Earnings Outlook

Japanese corporate earnings have shown a mixed trend so far in the October-December period, with the January 2020 revision index for FY19 recording –13.8%, down slightly from the December figure of –11.5%. The recovery in earnings appears to have been weaker than anticipated, particularly in the manufacturing industry, with the auto components and machinery segments among the most affected. On the other hand, the pharmaceuticals sector has seen relatively strong trends. The potential impact of the coronavirus, with the toll crossing 900 so far in February, could also have a bearing on annual earnings. An expected downtrend in the Chinese economy, one of Japan’s leading trade partners could also prompt Japanese companies to revise their earnings guidance for the fourth quarter. The IBES estimates currently projects a 1.6% year-on-year decline in earnings growth on a 12-month forward basis.

Major Japanese companies, excluding those in the finance and utility sectors, are expected to record a fall in combined net profit for fiscal 2019 through March, affected by the slowdown in global growth, the prolonged US-China trade conflict and the spread of the virus. Earnings across other sectors are likely to continue to decline, with some automakers still unable to resume operations at their plants in China, and a significant drop in demand from foreign visitors at department stores due to the spread of the new deadly virus. China’s response to the epidemic has been fast and forceful, giving reason for confidence that growth rates will slow dramatically. It seems reasonable to assume, nevertheless, that there will be lost opportunities particularly for companies producing in China that have not yet been factored into forecasts. On the economic front, analysts expect the economy to shrink in the fourth quarter of 2019 as a sales tax hike that came into effect in October hit consumption. Consensus estimates had forecasted a modest rebound this year, but the timing of a pickup in growth is now clouded by the virus outbreak in China, one of Japan’s top export markets.

Emerging Markets

Monthly review

Emerging markets fell in January and underperformed developed markets. Equities started the month on a positive note on upbeat economic data, the signing of the much-awaited US-China “phase one” trade deal, fresh monetary policy stimulus measures in China and easing geopolitical tensions between the US and Iran. Moreover, the Donald Trump administration lifted the currency manipulator tag on China. However, later in the month, share prices across emerging markets were dampened by growing fears over the outbreak of the novel coronavirus and on the lockdown of Wuhan, a major Chinese city at the centre of the outbreak. All emerging market regions and sectors posted negative returns. On the policy front, China lowered its bank reserve requirements by 0.50 percentage points to smooth liquidity conditions. At a sector level, defensives were the best performers, while resources and other cyclicals trended downwards as bond yields declined. The risk off-sentiment also weighed on metal prices.

Latin American securities also declined. as Brazilian equities fell amid unfavourable economic data releases. Brazil’s inflation numbers were worse-than-expected, led by higher meat prices. Meanwhile, Mexican stocks ended in positive territory, supported by a new trade deal between the US, Mexico and Canada. Elsewhere, equities in the emerging Europe, Middle East and Africa region declined due to tensions between the US and Iran. Russian markets slid in-line with global tensions and a fall in crude oil prices. Despite the increase in oil supply cuts from exporters, crude prices dropped on concerns that the novel coronavirus outbreak could weigh on oil demand from China.

Spotlight - Mexico Hot Spots: EM Team Visit Notes

The Emerging Markets team's trip to Mexico was an endeavour to find some hot spots in the Mexican economy. Since Andrés Manuel López Obrador (commonly referred to by his initials AMLO) took over and cancelled the construction of the new airport the Mexican market was increasingly unattractive. However, our viewpoint changed towards the end of last year and the trip corroborated our views that some areas of the market are attractive on a selective basis. Mexico has amongst the highest real interest rate in the emerging market world (~400 bps) which creates room for monetary easing. The relative spread with Fed Funds rate is high at~550 bps in a scenario when Fed has a dovish stance and creates room for easing without jeopardising currency stability. The approval rating of 70% for AMLO is intriguing given 0% growth, increased violence and a halt to important infrastructure projects. His popularity is attributed a rhetoric of inclusive growth and the direction of policy rather than results at this stage. The corporate sector was riddled with distrust leading to a balance sheet freeze, although there are signs of some rapprochement.

There are early signs of confidence building including the National Infrastructure Plan - USD43 billion of private infrastructure investment. Consumption, however, remains weak with zero to negative volume growth and weak forward commentary.

Global Emerging Market Equity Strategy PMs View On Coronavirus: Given the sharp move up in December and early January, we had trimmed the China exposure to capture profits. Whilst we don’t have the ability to predict how events will unfold, history has shown us that on average, past epidemics have several months to phase out. We also anticipate that the government may seek to temper the effects by lending support to the economy. We are not inclined to reposition the fund into the sell-off but may seek to take advantage selectively where compelling companies have sold off in the wake of news flow.

Asia Pac ex Japan

Monthly review

Asia Pacific ex Japan equities fell in January. The market started on a positive note, but gains were pared in the second half of the month over concerns about the impact of the novel coronavirus on global growth. Most sectors ended in negative territory, with real estate and industrials among the leading decliners. The energy sector detracted due to a sharp fall in oil prices. Chinese equities slid, as investors focused the potential impact that the novel coronavirus would have on the economy in the near term. China has taken several substantial measures to curtail the contagion, including extending the Chinese New Year public holidays, and imposing large scale quarantines and travel restrictions. Meanwhile, robust economic data and stimulus measures by the central bank supported sentiment in first half of the month. The Chinese economy grew in the fourth quarter compared to a year earlier, in line with estimates and unchanged from the previous quarter’s pace. The People's Bank of China announced a further cut in the reserve requirement ratio to inject liquidity into the banking system and support small and medium enterprises and private sector firms.

The Hong Kong market retreated due to weakness in Macau-based gaming companies and real estate stocks. Taiwanese and Korean equities edged lower amid the global risk-off sentiment. Both Taiwan and Korea registered higher than expected year-on-year economic growth in the fourth quarter of 2019. Indian equities ended in negative territory but outperformed the broader market, supported by encouraging inflows by foreign institutional investors. Australia was the only market in the region that edged higher during the month, as health care stocks posted strong gains. Indonesian stocks fell due to a decline in the utilities and energy sectors. Bank of Indonesia left its key policy rate unchanged, while losses in the utilities and consumer discretionary sectors weighed on Malaysian and Philippines equities.

Spotlight - Asia PMs View On Coronavirus Impact On China

The coronavirus outbreak was an unforeseen event and China responded with several substantial measures to curtail the contagion. We are likely to see disappointing economic data in the first quarter in this environment, and, consumption will be the worst impacted, in particular, as this holiday period traditionally sees considerable discretionary spending. We are witnessing a notable slowdown in online consumption, as a combination of CNY holidays as well as fear of contagion has significantly slowed down the delivery network to a near standstill. What we are also seeing is a focused attempt from online gaming, streaming and education providers to attract consumer attention to the services they offer in the safety of the consumer’s home. Against this backdrop, overall corporate activity may experience weakness too, which may filter down to global supply chains and the impact would be felt more widely. The pace of infrastructure activity will depend on how projects pick up in late February.

It is extremely challenging to forecast the duration of this outbreak and the extent of the contagion. It would not be surprising to see bouts of volatility in Chinese stocks in the near-term as both corporate and investors have little visibility on earning impact from this event. The Chinese government is demonstrating its proactive stance and has already been infusing liquidity into the market, which reiterates its firm commitment to maintain a stable pace domestic economic activity. We could see greater impetus in Chinese government’s policy support to accelerate the development of innovative drugs and the outbreak could draw additional attention to the importance of life insurance protection products. It is widely expected that in this environment, there will be more evidence of offline to online shift in the consumption spectrum.

While we acknowledge that this event is causing distress over the short-term, it is less likely to disrupt the long-term structural change that is unfolding in China and in Asia. The Chinese stock market, as well as the Chinese economy, are significantly deeper and wider compared to their status at the time of the SARS outbreak.

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