Well Done Tech: Time To Hand Value The Baton

HIGHLIGHTS

• August saw the US equities breaking multiple all time highs, driven primarily by tech stocks. Risk on market sentiments were strong due to positive developments in (1) Covid-19 vaccine, (2) Phase 1 trade deal and (3) Continued improvements in the global economy. In early September, we finally started witnessing the Well Done Tech: Time To Hand Value The Baton
• Long awaited correction in technology shares we had warned about last month
• Increase in vaccine news flow is expected to take over as the main driver of financial markets. Vaccine sensitivity favours value / cyclical stocks, and a rotation of growth to value has been long overdue. There are signs this scenario is starting to materialize now, given the improvements in the breadth of the rally
• Market corrections are healthy in ensuring the longevity of the rally. Expect volatility ahead with Covid-19, US elections and geopolitical tensions all remaining as key risks. We continue to recommend a “barbell” strategy to weather all possible circumstances

A Long Awaited Correction After Hitting All Time Highs

The financial markets were very optimistic for the month of August. As conveyed in our previous navigator, gains had been constant and strong, since the June consolidation. Technology stocks single-handedly led the global equities rally, albeit questions remain over how long the bull market can really last. Indeed, the S&P 500 and Nasdaq broke multiple all-time highs after surging past pre-Covid levels earlier. News of (1) positive Covid-19 vaccine development, (2) re-affirmation of the Phase 1 trade agreement between US and China as well as (3) improving economic data all contributed to the tremendous risk-on market sentiment. During the Jackson Hole summit, the US Federal Reserve also signaled longer periods of low interest rate following the shift of policy to “average inflation targeting”. Many investors read this as an effective floor for risk assets, while simultaneously still expect more stimulus from both the central bank as well as lawmakers. In early September, a correction in technology shares occurred breaking the upside momentum, exacerbated by aggressive call option positioning. Nevertheless, we remain positive on equities. We expect to see a rotation from growth stocks to classic value and cyclical stocks amid an increase of positive vaccine news flow to take over tech as the main driver of the financial markets.

Overdue Rotation May Be Near The Horizon

In the latest earnings season, many mega-tech companies beat earnings estimate with forward earnings forecasts being revised up. Optimism on the tech sector was at an all time high, and this was evident from the performance of the Nasdaq, a primarily technology driven Index, which gained around 76% from March lows. Technology and growth stocks have recovered and rallied so quickly, that value stocks are now looking increasingly attractive. The premium of the MSCI growth vs MSCI value have almost tripled since 2018.

If we look to just the FAANG stocks alone, the gain of 124% since March to the recent peak dwarfs that of the S&P 500 Index. In fact, when we look to the equal weighted S&P 500 Index, it has just barely climbed back to pre-Covid levels. This essentially tells us that the rally has yet to translate to the broader market. Clearly, a rotation away from mega-cap tech stocks has been long overdue. Signs of this scenario were finally witnessed in early September, where 74 stocks on the S&P 500 concurrently hit all time highs in a single day.

Expected Increase In Vaccine News Flow: Cyclical / Value To Benefit

Our view, as conveyed since the Mid-Year outlook, is for an increase in positive Covid-19 vaccine news flow from now towards year-end. Financial markets cheer whenever an improved news has been released. 23rd August was the last major vaccine news, where the US FDA announced an “emergency use authorization” of blood plasma from recovered patients as a treatment option, while the Trump Administration was considering bypassing normal US regulatory standards to fast-track an experimental coronavirus vaccine from the UK. According to our sensitivity study among markets and sectors, we found out a number of cyclical / value sectors tend to seemingly react stronger to such news.

This makes sense as well from the business cycle point of view. An approved vaccine will eventually signify that the end of Covid-19 is in sight, and ultimately point towards a longer-term  return to normalcy. Social distancing restrictions may be eased even further should the vaccine prove efficient in tackling the Covid-19 virus. Sectors that has come to a complete stand still will likely restart, while an increase in global demand should boost employment over time. Typically, this would suggest the start of a new economic expansion. It is no wonder why cyclical / value sectors are the most sensitive to positive vaccine news.

In terms of countries, demographics and economy play a huge role in market reaction to vaccine news. EM countries stand to gain the most. Many of these countries are in fact the most severely affected by the coronavirus, both socially as well as economically. These include tourism, domestic consumption, and manufacturing heavy nations such as Indonesia and Thailand. They are also the countries most likely to pounce on any first vaccine opportunities, which may prove the most economically sensible in their fight against Covid-19.

Corrections Are Healthy: Barbell Approach To Weather The Volatility Ahead

While we are getting used to the “new normal” in social settings, investors also need to get used to the new normal of ultra-loose monetary policy globally. Like we have stated in the past, the accommodative stance and excess liquidity do support higher valuations, but earnings will have to be justified ultimately. Strong earnings by many big tech firms is reassuring, but for the rally to be sustainable, corrections are important and healthy.

We have since witnessed the US equities market retreat from all-time highs at the start of September. The momentum was building for a while now, as speculative buyers of upside call options helped to drive big upside moves in individual technology stocks as dealers hedge their exposure by buying the underlying stocks. Naturally, profit-taking as well as valuation concerns resulted in the increase of volatility. Importantly, value stocks have been outperforming on relative terms during this period.

The expectations is for economic data to improve going forward, given the low base after a standstill in economies globally. With this, we believe that tech stocks are likely to take a breather and allow cyclical / value sectors to play catch up and broaden the rally. It is also important to keep in mind the various other key risks such as worsening of the pandemic, US elections and geopolitical tensions.

Therefore, we continue to recommend a barbell approach going into the last quarter of the year. We have no doubt about the long-term outperformance of growth stocks, but in coming months, the rotation into cyclicals/value maybe just beginning, particularly given the likely increase in positive vaccine news flow.

CIO INSIGHTS - GDP & CPI FORECASTS

GROWTH

• Economic activity was in line with our expectations, and even more resilient than expected, especially for the US. In 2021, the effects of the massive stimulus program and central bank bond purchases should drive higher growth in developed countries.
• The US payrolls report showed that the US unemployment rate fell to 8.4%in August, well below forecasts of 9.8% while the economy added 1.371 million jobs, compared to forecasts of 1.4 million. Fed Chair Jerome Powell backed the jobs report as a 'good one' and reiterated that the Fed's pledge to maintain interest rates lower for years to support recovery from the coronavirus crisis and recession.

INFLATION

• Inflation continued to fall in Europe due to the fall in activity, demand, and the sharp deterioration of the labor market. Deflation is the main risk in the Eurozone. We believe that the ECB will have to increase its PEPP programme before the end of the year to address the problem of a lack of inflation. On the contrary, US inflation is rising, with a rising risk of overshooting in medium term.
• EM inflation is declining because of the negative effect of the recession linked to the Covid. EM central banks have room to relax further monetary policies given the low inflation.

CIO INIGHTS - EQUITIES

• US elections and geopolitical threats are pointing to a period of market volatility. However, we believe significant downside risks are limited, as (1) global economy is on healing path and the worst in earnings is behind us, (2) vaccine news should be increasingly promising, and (3) policies will stay ultra-accommodative. We encourage investors to take advantage of market weaknesses to buy pro-cyclical assets.
• We upgrade Indonesia to positive as  (1) the market has been underperforming and is sensitive to positive vaccine news, (2) there is room for further fiscal and monetary easing, and (3) the market would benefit from growth to value rotation.  
• Sectorwise, we upgrade consumer staples to positive and downgrade energy to neutral in Asia. We expect large Asian staple leaders to recover rapidly when the pandemic situation stabilized, thanks to their scale, better distribution capabilities and ability to flex manufacturing to meet shifts in demand. Asian energy companies rebounded with oil prices in the past quarter, while further upside is dependent on a sustainable growth in demand. 

CIO INSIGHTS - FIXED INCOME

• Fed Chair Powell announced that the Fed will move to a new regime of targeting an average inflation of 2% over time and allow unemployment to drop below levels previously considered inflationary, without triggering rate hikes.
• Both Asia USD bonds and local currency bonds were flat in general in August, while US high yield outperformed. However, we prefer to stay neutral on US High Yield after the rally. The current level of spread does not compensate for expected default losses in the coming months. Fallen angels are peaking now, a sign that the recovery is underway.
• We keep our positive stance on Hong Kong and Singapore credit. We are generally very comfortable with HK blue chips companies given their long operating history and prudent risk management. Moreover, the tycoon owners of these companies have abundant  “personal liquidity” which can act as an additional layer of support when their flag ship companies run into financial difficulties.
• For China credit, valuations are not cheap, but liquidity is abundant and supply is manageable. As fundamentals have weakened, we would advocate to be selective and to stick with short to medium duration from quality names and laggards for Chinese High Yield property.

CIO INSIGHTS - FOREX

Note: + Positve /  = Neutral /  - Negative

EUR: The EURUSD broke above 1.19 in August to a 2-year high. After a strong rally, we forecast a correction in the short-term with our 3-month target at 1.16. In the medium term, we expect a resumption of the US dollar weakness, with our 12-month target revising upward (from 1.16) to 1.22.

JPY: The immediate impact of Prime Minister Abe stepping down due to health issues on the yen was positive. We do not anticipate any major change in monetary policy, given the huge expansion of public debt and the difficulty escaping from low growth and low inflation environment. We keep our short-term target close to the 50-day moving average around 106. However, we have revised our 12-month target to 102 (from 106), reflecting our bearish view on the US dollar.

CIO INSIGHTS – ALTERNATIVES & COMMODITIES

COMMODITIES

GOLD: We remain positive on gold as its key drivers remain in place – (1) real bond yields should remain negative or very low for longer, (2) massive quantitative easing is scaring some investors and reinforce the attractively of gold as a hedge, (3) dollar weakness and geopolitical tensions are additional catalysts. Our 12-month target range is $1900-2100/oz.

OIL: Reduced investments in the shale oil industry but also in classical oil fields will weight progressively on the production. Together with effects of the OPEC+ restrictions and the demand recovery, we expect Brent oil prices to move in the upper part of the $45-55 expected trading range by end-2020 and above in 2021.

ALTERNATIVES

LONG-SHORT EQUITIES: We are positive on long-short equities. The Covid crisis creates losers, offering attractive long/short opportunities for fundamental stock pickers. Short restrictions in continental Europe have been lifted. We are becoming more comfortable with quantitative market neutral strategies.

GLOBAL MACRO: We are positive on macro managers. Increasing deglobalization and differentiated country fiscal policy should offer more relative value opportunities. Upcoming US elections could usher a big change in US politics, with equally massive potential impact on markets.

Source: BNP Paribas Wealth Management as of 31 August 2020

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