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Before providing some contours of our (preliminary) equity market outlook for 2021, let us first contextualize recent developments.
2020 has been a year marked by wild market swings and the month of November, till now, has been no exception, quite the contrary. Although VIX levels have been nowhere near the levels seen in the beginning of the year (when the first COVID wave hit our shores), equity internals have been extremely erratic over the last couple of weeks. Two successive risk-abating events have come to the surface, both of them causing significant sector rotations. And this has happened in a polarized equity market context rarely seen before. As a reference to this polarized equity environment, we would point out to the large GICS1 sector performance dispersions up to 70% in 2020 (e.g. IT versus Energy) or the strong leadership of growth tilted equities during the biggest part of 2020 (see graph below). The purpose of this write-up is not to dwell on the fundamental causes of these large discrepancies nor to ‘re-open’ the inflation debate (see our previous CIO’s view), but it is rather to paint the equity environment preceding the above mentioned market-moving events.
Annual performance MSCI growth versus value
Source: DPAM, Bloomberg
First, up until the US elections outcome (which is still being challenged as we speak), the overriding consensus was for a ‘Blue wave’ to materialize, facilitating massive fiscal policies to be implemented – financed in part by higher tax rates – and scrutinizing more the monopolistic powers of Big Tech. On the 4th of November – the day after the election – when evidence started to gain traction that such an outcome would not take hold, with a split Congress, the S&P500 index rallied more than 2%. What is particular about that day’s move, is that it exhibited more declining constituents than advancers. Big weight constituents like Big Tech and Healthcare related companies rallied due to lower regulatory fears (and especially pharma companies that had sold off in anticipation of the US elections), while the more cyclical tilted sectors such as banks tanked, as did US bond yields.
One week later, the announcement by Pfizer and its partner BioNTech that their novel MRNA product showed an outstanding 90% efficacy level in combatting COVID 19 helped the markets propel higher. At the time of writing, Moderna has issued a press release, claiming an even higher efficacy for its vaccine candidate with a similar mode of action. An effective (and widely administered) vaccine has always been the missing catalyst to kick-start a balanced recovery, regardless of the vast monetary and fiscal measures that have been implemented (and still being contemplated) or the savings that consumers have been accumulating. This time around, opposite sector moves were noteworthy, with cyclical and COVID-impacted sectors rallying hard, with at the other end of the return’s spectrum, noteworthy laggards being tech companies or areas of our economies largely unaffected by COVID. Yields shot up, with the US 10-year making an attempt to clear the 1% bar. The daily return gap in Europe between the worst and best sectors was more than 10%, which only happened seven times before in the last 25 years (and twice in 2020). While these daily moves are rare, we can certainly understand the rationale, on account of markets participants’ positioning, shorter investment horizons and the prospects of a more synchronized recovery. As such, violent equity portfolio rebalancing is not surprising, with market participants buying or covering shorts on the laggards. In our previous CIO’s view, we emphasized that several of our strategies had increased selectively their exposure to beneficiaries of a re-opening economy.
We expect the largely range-bound equity environment (we had seen over the last 6 months) to be put to rest and we anticipate broader subsector market participation as a healthy and welcome development. Additionally, the Q3 results season has demonstrated that companies at large have been able to preserve their profitability relatively well, which bodes well for future operating leverage. Despite lingering and legitimate Brexit worries (with the worst case scenario out of the way, given the resignation of Dominic Cummings, top advisor to Boris Johnson and the personification of the hard Brexit), European markets should outperform due their higher cyclical and value tilt. The implementation of the EUR750 billion Next Generation EU Fund in 2021 should provide extra impetus, together with the abundant liquidity provided by continued quantitative easing and liquidity parked in money market funds. Time will tell for how long some of these value tilted sectors will be reinvigorated but the window of opportunity is certainly present for value to outperform in the coming months. We repeat it is important to be selective in picking so-called Covid-losers or cyclical companies. The quality of the business model, the balance sheet and the potential to emerge stronger from the Great Corona Crisis are key aspects in this selection process. Back in 2016, the Eurostoxx Banks Index nearly doubled in a couple of months, but after this short resurrection, has continued to underperform the broader market. Some business models are broken or disrupted and as long-term oriented investors, it is important not to lose sight of this.
The COVID crisis has taught us that digital capabilities (be it as product or in terms of process set-up) represent a real competitive advantage for companies and that providing solutions to societal challenges will only become more pressing. COVID 19 has accelerated some pre-existing structural trends that will not vanish if and when the disease is eradicated, quite to the contrary. Therefore, as said on previous occasions, the core of any equity portfolio should be consisting of quality companies that are able to grow their top line through the cycle, with competitive advantages, relatively low leverage, less prone to disruptive forces and ideally able to capitalize on the United Nations’ Sustainable Development Goals (SDGs).