This is where the most underpriced equities are hiding
Equity markets delivered extraordinary returns in 2020, but, given the return of uneven and contradictory news flow, the first quarter of 2021 will certainly test investors. Expectations of further monetary and fiscal stimulus, along with positive news on vaccines, have helped support equity markets. However, a new variant of the virus is putting increased pressure on healthcare systems, and we are seeing more and more countries locking down again.
We believe this will have economic repercussions for many and, at a minimum, will defer some of the fundamental rebound investors have been anticipating. We also need to factor in political change. What does the “blue wave transition” in the US mean for companies and policy decisions, especially around taxation and US-China relations?
As we look out to the rest of 2021, we
remain optimistic when we analyse
the return potential of global equity
markets. However, volatility is likely to
increase, in part, as higher dispersion
within factors, styles, and sectors
emerges. For investors to try to make
money in this environment, they will
have to be more selective and active,
which may at times mean taking a
more contrarian approach.
Navigating through a COVID‑on/COVID‑off environment
We expect the COVID-on/COVID-off
trade to continue to flip-flop back and
forth as it did through the later stages
of 2020. We believe secular growth
stocks, at the right price, should
continue to compound good returns,
but the setup into mid-year might imply
a continuation of the rotation trade
into value, small-caps, and non-U.S.
stocks that began toward the end of
last year. Certainly, increasing exposure
to stocks with earnings sensitivity at
this point in the market cycle could
potentially reap rewards. But selectivity
will remain crucial in a world that
remains defined by extreme outcomes.
Further positive news on vaccines would
also help those sectors that have been
most damaged by the virus, such as
travel, leisure, energy, and financials.
Indeed, we have been adding individual names to these areas but have been
very selective, using our global research
platform to identify the best candidates.
We have increased our exposure to
financials. However, rather than focusing
on traditional banks, where zero and
negative interest rates continue to
hurt balance sheets - we have instead
been concentrating on areas such as
investment banking, insurance, and
investment managers. These are
companies that should actually benefit
from a lower interest rate environment.
While new vaccines should eventually
allow us to exit this pandemic, we believe
that many of the trends that have evolved
over the course of the past year will
endure. COVID-19 has unleashed these
trends even further. We expect increased
adoption of digital payments, having
food delivered to your door and using
technology to connect with each other.
There has been a meaningful
step-change in the penetration of
e-commerce globally, and we believe
there is still a long way for this dynamic
to go. The advantage for us, as global
investors, is that the opportunity to scour
all geographies using our global
research platform to find, in our view,
the best investment opportunities.
Looking beyond the US to discover new opportunities
With US equities having performed so strongly, we have been looking for better value elsewhere. Asia-Pacific and Europe are the two places where we have been increasing our exposure.
It is our belief that Asia is the place where the gravity of the world is moving toward. It’s where markets are deepening the most, where economies have been growing the fastest, and where, currently, the most billionaires are now being created. In that sense, it is where the most unpriced change can be found for investors.
China’s recovery from the pandemic has been in stark contrast to developed markets. It is likely to be one of the few countries to see positive economic growth in 2020. More generally, while the emerging market (EM) growth premium has been decelerating for some time and collective earnings have been disappointing, many individual EM economies retain long-term advantages when thinking about the potential return generation from equities.
Today, our preferred markets are in India, Indonesia, the Philippines, and Peru, while we also have high-conviction positions in Chinese consumer stocks.
We also believe that Europe now looks
more attractive. Although it doesn’t
offer the breadth of high-growth
opportunities that the US or China
can offer, there are a number of
change-driven stocks we feel
confident about in a world that should
be marked by improvement, especially
from spring 2021 onwards — either where
stock valuations have fallen sharply,
priming them for reversion, or where we
have identified a fundamental change in
a company’s earnings profile. Key for
us, at this point in the equity cycle, is
the ability to find profits growth, as this
remains the most powerful driver of
stock prices over the long term.
In a complex macro environment, a stock‑specific focus is key
One natural concern is whether equity markets have rebounded too strongly and quickly, especially given the concentration of stock returns. This does create some potential for a broad bubble to form if good news is uninterrupted.
Our view, however, is that although
valuations are at a premium in an
absolute sense, we are also in a world
of unparalleled monetary and fiscal
support, which has naturally supported
risk assets. Interest rates across the
globe are at rock bottom, while at the same time, there is a huge wall
of money looking for a home. On that
basis, we don’t believe that valuations
are extreme, and equity markets will
continue to offer opportunity, especially
relative to alternatives.
The environment, however, is inherently
more stock-specific than it has been
for some time. 2021 is likely to present
opportunities to invest in bouts
of volatility. This is certainly likely if
conditions worsen before they get better,
and we believe there will certainly be
data points for market bears to point to
in the coming months ahead.
There are also clear concerns in the
market that, beyond monetary support,
there is no fundamental improving
“bull” case for global equities. However,
this aggregate top-down perspective on
the world belies the ongoing breadth of
stock-specific fundamentals we continue
to find, especially in secular growth stocks
benefiting from changes in society and in
A world of dispersed valuations and
corporate outcomes are ultimately
beneficial to active investors, and we
shall look to exploit those factors for our
clients in 2021.