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Overall, we remain bearish on global equites mainly based on the extremely uncertain macro environment. Our base case scenario is not long lasting but consists of an unprecedently deep global recession with the market volatility remaining in place for Q2. An order of magnitude for the economic downturn is yet to be determined but we would not be surprised if the equity markets retested the March lows as there is a high dispersion of expectations on the macro data being released. Current expectations and estimations for earnings will be more unreliable than normal with too many ‘known unknowns’.
At the same time, we appreciate that valuations for many stocks have become much more reasonable compared to the previous quarter end and could even become appealing if corporations are able to survive and potentially even thrive during the harsh global downturn. The sharp market drawdown in March was partly caused by liquidity stress leading to stocks being sold across the board. It is this activity that creates a good buying opportunity for companies in industries which are not directly impacted by the virus outbreak and further quarantine measures.
As a part of our equity strategy we have two baskets of stocks. The first basket consists of companies which were sold due to liquidity issues, but fundamentally remain strong despite the coronavirus outbreak and potential upcoming global recession. The second basket consists of companies which are from struggling industries and have strong enough balance sheets to withstand. Speaking about top down asset allocation, we prefer such recession resilient sectors as Information technology, healthcare, consumer staples, communication services, utilities. In contrary, the most affected sectors are financials, energy, materials, industrials and consumer discretionary.
Geographically, we prefer US and Japan and consider these markets as a base for building a core equity exposure going forward. We are cautious on UK and Europe due to their high exposure to financials, industrials and commodities.
Along with an aggressive monetary policy response of cutting interest rates to zero and re-introducing USD swap lines, US policy makers approved one of the most aggressive fiscal policy packages around the globe. The fiscal stimulus equates to $2 trillion or 9% of the country’s GDP. Additionally, the US fund market has the highest exposure (63%) to recession resilient sectors. Sentiment indicators show a mixed picture. The AAII Bulls to Bears Index is pointing to a lack of bulls among US individual investors which we interpret as a bullish signal. The put to call ratio for the S&P 500 remains below average but not as extreme to demonstrate that investors are moderately bullish. Technically speaking, the S&P 500 was initially unsuccessful in breaching the 2640 level several times in the run up to the end of the first quarter. Deteriorating economic data and the US virus situation pushed the S&P 500 back to 2450 level. The break above 2640 means that there is a chance that aggressive policy responses are enough to address the economic downturn, but we believe this to be short lived as it is prior to the release of company earnings, forward guidance and limited economic data. Most of our current equity exposure sits within the US. It is also based around the coronavirus resilient basket together with our e-commerce and digital life thematic ideas.
The FTSE 100 Index is heavily skewed towards financials, energy, materials and industrials which account for more than half of the constituents. We think that it is not prudent to call the bottom in these sectors ahead of economic data releases for March and first quarter corporate earnings. Policy response has been mixed so far with particularly aggressive monetary measures and moderate fiscal programmes. The Bank of England lowered the base interest rate by 0.65% to 0.10% and increased the QE program by £200bn. On the fiscal side there are £30 billion worth of stimulus packages and £330 billion of government backed loans and guaranties. Sentiment indicators points towards neutral with the put to call ratio for the FTSE 100 staying below average but not at extremes with investors appearing to be moderately bullish. Technically speaking, the FTSE 100 is staying just above the lower boundary of 5400-5700 trading range. Failing to maintain the 5400 level, will make a retest of the March low or 4900 level highly likely. On the upside, if the index goes through the 5700-5800 zone, it will increase chances for further rally.
The Euro Stoxx 50 Index is skewed towards sectors which we expect to be impacted the most by a global recession. The economies of core European Union countries have large exposure to industrial corporations and car manufacturing industries. Companies of these industries have high operating leverage as they need to carry high fixed costs even during shutdowns. As a result, we are reluctant to speak about valuations until we can reliably assess the impact on earnings. Sentiment indicators point towards a neutral view with the put to call ratio for the Euro Stoxx 50 staying near the 5-year average. Technically speaking, the Euro Stoxx 50 picture is similar to that of the FTSE 100, with 2650 and 2800 levels to watch for further downside and upside movements respectively. We have marginal exposure to European equities through our coronavirus resilient basket which is looking at a combination of consumer staples and food delivery companies.
The Nikkei 225 Index has the second highest exposure to recession resilient sectors (52%). Before the pandemic caused economic slowdown, the Bank of Japan had limited ability for a monetary policy response and it was forced to go further than any other central bank. The monetary authority has been purchasing stocks via ETFs to stabilise the market. Fiscal policy response is large and equates to YEN 58 trillion or 10% of the country’s GDP. Sentiment indicators point to neutral with the put to call ratio for the Nikkei 225 staying marginally above the 5-year average. Technically speaking, the Nikkei is failing to stay above the support level of 17600 which make it likely to retest the year low of 16400. 19400 is a key level to breach for a potential upside move.
We prefer Emerging markets the least as they are typically more geared to global growth and commodity prices. Central banks and fiscal authorities in these countries have limited ability for policy responses. Many emerging markets will face dilemmas of providing monetary stimulus and pushing their currencies towards further depreciation or protecting the foreign exchange rate via higher interest rates. Currency depreciation will stimulate export-oriented companies, but this could create higher inflation and hurt consumers’ disposable incomes sharply in the short-term. Higher interest rates will further burden domestic production and drag consumer disposable income down gradually. There is also risk of social instability especially in authoritarian ruled states. We have a very limited amount of EM exposure and mainly hold single stock equities in line with our thematic ideas of EM consumer disposable income growth and e-commerce.
Past performance is not a reliable indicator of future returns. Forecasts are not a reliable indicator of future returns. If the information is not listed in your base currency, then the result may increase or decrease due to currency fluctuations.
If not otherwise indicated, all graphs are sourced from Dolfin research, April 2020.
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