- Equity markets hit the skids in 2022: January proved a tricky month for financial markets worldwide, as air was seemingly let out of the retail investor-driven asset bubbles in stocks, recent IPOs, SPACs, high yield credit, and cryptocurrencies.
- Tech wreck hurts retail investors: retail investor favourite assets have suffered from the pullback in market liquidity as retail investors seek to preserve whatever gains they have left in these assets, in this Federal Reserve-inspired risk-off market move.
- A correction, not a crash: we do not see the preconditions for a bear market in stocks, notably from economic recession, overtight financial conditions and credit contraction. Strong earnings momentum, negative real rates and enduring easy financial conditions support equities.
- Key risks: US Federal Reserve over-tightening of monetary policy is a key risk for equities, e.g. > 4 25bp rate hikes and faster Quantitative Tightening. A flare-up in Russia/Ukrainian tensions is the second geopolitical risk to monitor.
- Quality dividends: Amidst the tech wreck, European dividends hold up: conservative investors looking for yield can find an outperforming solution in European quality dividend strategies, yielding > 4% annually.
- Commodity prices stay high, favouring Basic Resources: industrial metal prices remain close to recent multi-year highs, with structural demand underpinned by electrification of the global economy.
- UK equities have a long way to catch up post Brexit: UK large-cap equities have been one of the best-performing regions since November 2021, helped by cyclical exposure to commodities and financials.
- Stay the course with small-caps: Small-caps globally saw a sharp outperformance between November 2020 until March 2021 in the US and September 2021 in Europe. We still believe that this environment of above-trend real and nominal growth, post-Omicron domestic demand rebound and buoyant M&A activity favours small-caps, particularly in Europe and Asia.
1. Global Equities Overview
Equity markets hit the skids in Jan 2022
January proved a tricky month for financial markets worldwide, as air was seemingly let out of the retail investor-driven asset bubbles in stocks. Most retail investor favourite assets (non-profitable tech, IPOs, SPACs, crypto) have suffered from the pullback in market liquidity as retail investors seek to preserve whatever gains they have left in these assets, in this Federal Reserve-inspired risk-off market move.
UK equities have a long way to catch up post Brexit
UK, Sweden and France are outperforming within Europe: favour the commodity exposure in UK large-caps which are driving bullish EPS growth forecasts, while the industrial exposure is the primary momentum driver for both the CAC 40 and OMX indices. Merger & acquisition activity is also heating up quickly in the UK, with UK assets seen as very attractively valued.
2. Investor Sentiment
"Be Fearful When Others Are Greedy and Greedy when Others Are Fearful“ – Warren Buffett
US retail investor sentiment has hit rock bottom, according to the weekly AAII sentiment survey. At a bull - bear spread of -30%, this is today as low as the level reached back in 2010, 2013, 2016 and 2020, i.e. fearful. While we cannot characterise this as panic selling by retail investors for now, this is nevertheless an extreme move.
Short-term contrarian positive signal
A contrarian buy signal? Traditionally, an extremely bearish reading in the AAII bull-bear sentiment survey (like today's reading) has been a good contrarian indicator in the short term. This suggests that we could see a continued rebound in stock markets, at least in the short term. However, the Russia-Ukraine conflict remains of course a wildcard.
3. Small-Cap focus
We continue to believe in a small-cap bias
Small-cap outperformance from November 2020 has partially unwound: November 2020 saw sharp outperformance from small-caps globally until March 2021 in the US, September 2021 in Europe and December in Emerging Markets. We still believe that this environment of above-trend real and nominal growth, post-Omicron domestic demand rebound and buoyant merger & acquisition activity favours small-caps, particularly in Europe and Asia.
Over time, small-caps have performed 2x or more vs large-caps
The long-term trend remains your friend: the long-term trend from 2000 onwards is clear, i.e. small-caps outperform over time by a large margin in each geography, compared with large-cap stock indices. Note that the long-term trend looks particularly solid for European and UK small-caps.
4. Q4 2021 earnings season underlines growth
In the US, 77% of companies have announced positive earnings surprises, beating expectations on average by +5%
There were concerns that Q4 2021 earnings might not be as superb as in previous quarters. A déjà vu? Many companies are facing rising costs (wages and technology, energy, logistics and raw material costs), but in spite of this, profits in most sectors continue to grow and positively surprise. Higher costs are being passed through to end clients with often a positive impact on profits! And guess what? There are even signs that supply chain issues are improving, even in the trucks/automobile industry.
All in all, in view of the outstanding results from certain major tech companies, virtually all sectors are now announcing reassuring earnings.
In Europe, 60% of companies which have reported so far have beaten earnings expectations on average by +12.6%
In Europe, the earnings season is just beginning. Only a quarter of the main companies have reported so far, compared with more than 50% in the US. Several bellwethers have also announced very strong results and forecasts (especially in the luxury, energy, banking sectors and some techs).
We think that 2022e IBES consensus earnings growth forecasts (c. +7% for the US and Europe) are too conservative. We expect around +12% earnings growth, considering the strong economic outlook, favouring cyclicals, small-cap equities.
5. Asian Equities Overview
China shifts to easing mode, in contrast to the rest of the world
• Since Beijing set stability as a top priority in late December last year, more easing measures have come through e.g. cutting key lending rates, relaxing some property restrictions and stepping up support for the small- and medium-sized enterprises. The government pledges to cut fees and taxes with a combination of fiscal incentives to boost the slowing economy.
• We are positive on China equities. Improving credit impulse has been historically positive for markets. We prefer domestic China A-shares particularly small- and mid-caps as they would benefit directly from policy easing.
• Hong Kong-listed Chinese equities could see a gradual reversion to the mean this year given their cheap valuations and below-average global investor positioning. However, a sustained rally would require more positive catalysts, such as more clarity on regulations and upward earnings revisions. A hawkish Fed and stronger USD could be headwinds and trigger volatility in the short term.
• The biggest uncertainty is the pandemic-related restrictions amid the “zero-Covid” policy. Positive surprises would be larger-than-expected policy loosening, signals of regulation relaxation on the internet and property sectors, and a resolution on the ADR de-listing issue.
6. Sector Allocation
After an excellent 2021 performance, we downgraded US REITs to = mid-January (cf. January Equities focus)
No other change for now as many uncertainties persist (inflation, interest rates, Ukraine, Omicron)
2022 started with a sharp increase in bond yields due to very high inflation (high prices of energy & other commodities, electricity, US housing & wages etc). The US Federal Reserve is now expected to hike interest rates higher and faster than expectations in 2021. Expensive sectors and stocks have logically corrected the most, technology in particular.
- Keep good exposure to sectors and asset classes acting as hedges against inflation, such as precious/‘battery’ metals, energy and financials. European real estate also looks heavily discounted.
- We also like healthcare, as it is still cheap and is showing very good cash flows. There is still obvious long-term growth there due to innovation, ageing population and people now more aware of their health, especially during the Covid pandemic.
- Defensive sectors have been a mixed bag in 2022. These defensive sectors which underperformed most in 2021 are logically doing a bit better early 2022.
In 2021, the fast economic recovery supported most sectors. As the economic activity is now at risk of overheating, central banks are taking action. Due to some increasing uncertainties, especially the Ukraine/energy crisis, we prefer to stay tactically and somewhat more defensive for the moment. Note, however that so far, corporate results have been quite good and this is providing support.
- We recommend staying on the cautious side until we start to see a stabilisation (or cooling) in the Ukraine/energy crisis and know what impact the Omicron variant is having on the global economy and inflation (production lines and supply chains remain disrupted).
- Consumers are still hesitant about venturing out and travelling, especially by plane, thus delaying the recovery in the services industry.
- In the tech/‘Metaverse’ space, we like e-gaming (good growth and M&As now taking place), electronic payments, cybersecurity, semiconductors and A.I.
- Stay clear of expensive/ disappointing/low profitable names! Value still shows much better momentum.