Equities Focus January
#Articles — 17.01.2022

Equities Focus

Edmund Shing, Global Chief Invesment Officer & Alain Gerard, Senior Investment Advisor, Equities

Norwegian Krone: upside potential I BNP Paribas Wealth Management

Summary

  1. Don’t be afraid of the Fed: stock markets typically rally in the lead up to, and circa 10% over the six months following the first Federal Reserve interest rate hike.
  2. Growth stocks have not all done as well as you think: contrast the average S&P 500 stock gain of 24% in 2021 with the very growth-oriented ARK Innovation ETF in the US which has lost 40% since February 2021, and with recent US IPOs, 27% on average below peak.
  3. Conservative hunt for yield: prudent investors who prefer steady income may consider equity dividend strategies with an explicit quality dimension. The quality-oriented BNP Paribas Europe Dividend, Wisdomtree Eurozone Quality Dividend Growth, and S&P Europe Dividend Aristocrat strategies have all delivered a 10%+ average annual return including dividends since 2012.

Key Recommendations

  1. The oil market pullback provides investment opportunities: at a sector level, we see a good entry point in enhanced commodity funds exploiting the roll yield in commodities with backwardation in futures curves. We like the Europe Oil & Gas equity sector post oil price pullback. On the other hand, after a great performance in 2021, we now downgrade the US REITs from positive to neutral.
  2. Revenge of mid/small-caps to come? 2021 was a boon to US tech mega-cap stocks: the DJ Global Titans 50 index gained 25% versus 13% for MSCI World small-caps. Since 1999, global small-caps have delivered a cumulative 749% return in US dollars, versus 261% for the Global Titans. Strong growth and merger & acquisition activity support our positive mid/small-caps view.
  3. Buy into the Circular Economy theme momentum: the ECPI Circular Economy Leaders index is benefiting from the focus on this sustainability theme, +37% in 2021.

Global Equities view

INFLATION ABOVE 4% could challenge equities

Inflation pressures may linger through 2022 and pose a risk of spiralling into a more persistent economic factor. Historically in these market environments, real assets—including natural resources and commodities—have outperformed stocks and bonds.

Investors have not faced inflation risk since the early-to-mid 2000s, and the most notable inflation period prior to that was in the 1970s. So this may mean that their portfolios today are not positioned for a prolonged inflationary environment.

Historically in these market environments, real assets—including natural resources and commodities—have outperformed stocks and bonds, particularly when CPI stays above 4%.

Within stock markets, sectors that have historically outperformed during rising rate environments include Oil & Gas, Mining and Financials.

US inflation needs to fall soon for equities to stay solid

In contrast, easing inflation could help EM

Emerging Markets equities are cheap and unloved relative to the US in particular. A constantly negative narrative, particularly around China, will likely reduce in intensity. EM economies are in good shape, having pursued economic orthodoxy and expanded fiscal stimulus less than in other countries.

Emerging Markets are an unloved asset class, and China, in particular is viewed unfavourably, in part because of overdue and heavy-handed regulatory activity. Looser monetary, fiscal and regulatory policy can create an inflection point for some compelling valuations in China.

Geopolitics are always a factor, but we see the prospect of a “hot war” over the Taiwan region as being very remote. Sustained easing of inflationary pressure, vindicating the Fed’s stance, would be positive for Emerging Markets, in our view.

The 1st Fed Rate Hike and Equities

DURING THE 5 months prior to, and 6 months post the first fed rate hike, equities typically rise

The first Federal Reserve rate hike in a new rising rate cycle is not typically a cause for concern for equity markets; it is the last hike we need to worry about. The first rate hike generally occurs in a context of strong economic growth and rising inflation. Equities rise prior to the rate hike, and for 6 months afterwards.

Equities should not fear the 1st Fed rate hike

500: >25% returns a good sign for the next year

We observe that 86% of the time that the S&P 500 has risen 25%+ in a calendar year (as in 2021), the index subsequently posts positive returns the following year as well, with a median +13% return.

Where can cautious investors buy today?

Hunt for bond-beating yields in Quality dividend and shareholder return strategies

Hunting for yield: prudent investors who prefer steady income may consider equity dividend strategies with an explicit quality dimension, as opposed to a pure high dividend strategy. The quality-oriented BNP Paribas Europe Dividend, Wisdomtree Eurozone Quality Dividend Growth, and S&P Europe Dividend Aristocrat strategies have delivered 10%+ average annual performance including dividends since 2012, 2% per year more than pure high yield strategies from MSCI and STOXX, at comparable or lower risk.

Choices for prudent investors

Conservative investors should favour minimum volatility and quality factor equity strategies

Conservative investors who are not concerned about generating dividend income may consider investing in stock markets via quality or minimum volatility equity strategies. Both factor strategies based on global equities have generated double-digit returns on average since 2012 (16% CAGR for MSCI World Quality, 11% for MSCI World Minimum Volatility) while suffering lower annualised volatility and drawdowns than for the benchmark MSCI World index.

How to (re)position your equity portfolio in 2022

Avoid expensive stocks, especially thOse with WEAK or disappointing earnings; be diversified!

After the strong rally end of 2020/early 2021, we have consistently warned against expensive names, particularly in Technology. And indeed, many of these stocks disappointed in 2021 and will still face a tough time in an environment of rising bond yields and interest rates. This does not mean that investors should stay clear of the tech space altogether. But we favour companies with strong, improving earnings, and solid prospects. Moreover, we like the Metaverse theme via semi-conductors, Artificial Intelligence, e-gaming, and cybersecurity. We favour sectors/companies with pricing power.

Navigate the inflationary environment and be optimistic ABOUT the future!

With inflation at a 40-year high, investors should lean towards equity ‘hedges’ against inflation and rising yields. Sectors/styles that perform well in this environment (and are still cheap) are Financials, Energy, Basic Resources (we like precious metals/‘battery’ stocks), value and small caps. We live in an era of unprecedented innovation, as well as health and environmental consciousness. This strong momentum will last; so opportunities can be found in healthcare, industrials (including automobiles) and clean energies, though selectivity remains an important consideration.

Sector Allocation

This month, we downgrade US REITs to neutral

2021 will be remembered as an excellent year for equities, particularly the most value/ cyclical parts of the markets, but less so for young, unprofitable or expensive companies. At the end of 2021, some defensive and lagging sectors such as utilities or consumer staples rebounded due to concerns relating to the new Omicron COVID-19 variant.

¡  In a context of high inflation and rising bond yields, we retain  exposure to raw materials, energy and financials. On the other hand, after superb performance in 2021 and a possible peak in inflation, we downgrade US REITs to neutral. We prefer EU REITs as they remain relatively cheap.

¡  We also like healthcare, as the sector is still cheap and showing sound cash flows (allowing investments, buy backs, dividends, M&A’s). There is still obvious long-term demand growth due to innovation, ageing populations and people being more aware of their health, especially today.

¡  Defensive sectors mostly under-performed over 2021.

Strong economic activity, accelerating inflation and robust corporate results favoured a more cyclical stance. Now, with the Delta variant still present, Omicron spreading extremely fast and ongoing supply chain disruptions, we prefer to stay tactically more defensive at the moment. We will review our stance with the coming 2021 corporate results and 2022-2023 updated forecast.

¡  We recommend to stay on the cautious side in the short term until we know better how much the Delta and Omicron variants are damaging the recovery and impacting inflation.

¡  Consumers hesitate to go out again and to travel, especially by air. Countries maintain entry restrictions. In the short term, this situation favours ‘stay at home’ stocks (technology, healthcare, staples, utilities) rather than the ‘re-opening’ travel & leisure sectors.

¡  We cointinue to like precious/ ‘battery’ metals as well as semiconductors.