Sector Focus

IN A WORD:

·       In early 2020, equity markets continued to rally. This rise was abruptly interrupted by the coronavirus epidemic in China. As a result, the defensive sectors performed better in January. But the markets want to believe that this epidemic will soon be under control and equity markets will resume their upward trend.

·       Two cheap and obvious sectors to play in the rebound/economic recovery context (positive recommendations): Energy and Financial Services, particularly Insurance globally, and US banks. European Technology and European Building Materials also have potential.

·       We still recommend caution on the Consumer Staples sector (-) and Industrials (-) because these two sectors are relatively expensive.

·       Publications of 4Q19 (FY19) company results have been reassuring in general in the US, especially the technology giants which have contributed the most to the rise in equity markets for the past year. In Europe, it’s only beginning of the reporting season, but there have been few major negative surprises so far.

Introduction : our recommendations obviously allow for the scenario in which the coronavirus in China, and to a lesser extent other countries, will remain relatively under control. Experience of recent epidemics (notably SARS) has shown that related market corrections have offered nice buying opportunities.

In January 2020, some of our favourite sectors did well (Global Health Care, European Technology). And vice-versa for cyclicals due to the coronavirus scare. Utilities have profited from their defensive nature, lower bond yields and the ongoing move to SRI. Indeed, many large companies in the sector are considered as very ‘socially responsible’ (as they are active in electricity, water, waste treatment, etc). We suggest a thematic approach for Utilities.

This month, we downgrade our recommendation on the Pharma/ Health Care sector from + to = based on the following factors:

-        The sector is no longer cheap after its rally in late 2019: P/E 2020 US Health Care is now 16.7 (against 19.2 for the MSCI USA index); and in Europe: 17.6 (against 14.9 for the MSCI Europe index).

-        High(er) chance/‘risk’ now that Mr. Sanders will win over some big states such as New Hampshire to become the democratic presidential candidate. This will at least bring higher volatility on the sector and a consolidation, maybe even a correction as Mr. Sanders plans to slash the very high costs for US patients.  This would put pressure on margins and profits in the whole health care sector.

-        The sector in general has performed very well over the last few months (second best performance in the MSCI World Index behind techno between 30/9/2019 and 31/1/2020: +11.73% versus +7.45%).

-        We are not turning negative on Health Care but it is now necessary to become more selective and rigorous with investment choices and entry/exit points due to sector volatility which is expected to rise.

-        We suggest to play Health Care today rather via a thematic approach, in particular Innovation considering that leading innovative companies shall be less affected by a potential healthcare reform in the US.

Apart from the Health Care sector, we are not making any other sector changes this month. The company results released to date largely support our industry views. For example, among industrials, some European flagship stocks have somewhat disappointed.

We remain cautious on Consumer Staples (-) and Industrials (-) as both sectors are expensive. Besides, airlines and transportation are a big chunk of Industrials and are more vulnerable to the coronavirus, especially after their sizeable rerating in 2019. Also remember Boeing's technological and safety concerns. The 2020 price-to-earnings ratio for Industrials has gone up from less than 15x in late 2018/early 2019 to around 18x currently, both in Europe and in the US.

Many investors are still underweight on Value and Cyclical stocks at a time when the valuation gap between Value and Growth stocks is still close to its historical highs. Two cheap and obvious sectors to play in the rebound/economic recovery context (positive recommendations) are Energy and Financial services, particularly Insurance globally and US Banks. The latest results and the health of major US Banks and other US Financials are quite encouraging, hence our positive recommendation. Idem for global Insurance. We remain neutral on European Banks and global Real Estate.

One industry that remains attractive and less affected by disruption is Building Materials in Europe (positive recommendation). Stocks are trading at reasonable valuations. Costs are fairly well controlled in the sector, with some pricing power over customers.

As the global economic recovery looks too weak at present to lead to significant increases in commodity prices, we remain neutral on Materials sub-sectors such as chemicals, mining, steel and metal. On the other hand, ‘Green’ investments are booming, which could selectively benefit some leading Industrial/Utility companies, especially in Europe.

US technology (=) is expensive but their financial results are strong and earnings are being revised upwards, especially in the semiconductor sector. We prefer (and recommend) European technology (+) because it is cheaper.

Please find attached the PDF that contains all annexes.