European and US investors returned from their traditional summer holiday period to a market pullback, with the VIX spiking to highs of 38 after hovering throughout August around the low 20s.
15.09.2020 | 08:15 Uhr
The US led the decline as the S&P 500 fell 4.3% over two trading days during the first week of September and the NASDAQ was down 6.2%2 . There may have been an element of profit-taking driving the pullback after the huge rally markets experienced since the March sell-off.
We are concerned that despite the market rally we have experienced since March, as we already look ahead to winter, exuberant investors may in time hit ice, with the potential to skid off the road. As the economic impact of COVID-19 becomes clearer and, potentially, support from governments and central banks tails off, the key risk is that the momentum could be derailed. The pullback may be a warning sign that a long-anticipated correction is on its way, which could be significant in scale.
Despite the positive sentiment in parts of the market, we do not believe it is the right time to increase equity exposure. The opportunity to raise equity levels may present itself before the end of 2020, should a correction bring valuations and sentiment – which are currently extreme – back to more reasonable levels, but we are prepared to be patient, seeking to maintain portfolio volatility close to target levels.
The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment. Past performance is no guarantee of future results. See Disclosure section for index definitions.
Since our last note on 21 August, we have not made any changes to our broad asset mix. However, we continue to look for tactical opportunities and have made the following changes, which we discuss below:
We are relatively optimistic on EU growth given the following:
1. The manufacturing sector’s stronger relative growth prospects in the short-term should benefit the EU greatly, as the sector represents a larger proportion of the EU GDP relative to the US. The EU also has stronger consumer spending trends and welfare support than the US. Moreover, short-term work programmes in the EU are expected to be extended in 2020. In contrast, the US’s supplementary benefits expired at the end of July 2020, with Congress failing to agree on further stimulus before the August recess.
2. The agreement of the EU Recovery Plan in July 2020, with capital of EUR 750bn expected to be mobilised in early 2021 through to 20243.
3. National fiscal spending plans have already been announced in Germany (worth 9% of GDP over 2020-21) and France (4% of GDP for 2021-22)4.
Overall, eurozone GDP growth is expected to be higher than in the US for the next three quarters. However, within the EU, we expect Germany to emerge from the crisis the fastest, having suffered relatively less of a hit to growth compared with other EU economies, and is better placed to outperform during the recovery. For this reason on 20 August we moved from neutral to overweight German equities.
With respect to fundamentals, Germany has contained the pandemic outbreak relatively well and we believe is well placed to continue to outperform on this front, owing to both more hospital capacity and a more effective health policy response. Moreover, Germany’s economy has a high share of manufacturing relative to EU peers and conversely a lower share to those sectors most affected by containment measures, such us tourism. The periphery’s elevated exposure to tourism and the recent disruption to summer travel, suggest economies such as Italy and Spain will likely see another outsized hit to growth in Q3 2020. Germany has also announced and implemented sizeable fiscal support year-to-date. When looking at valuations, Germany’s attractive relative FY2 PE multiples and an under-allocation to the country by investors support the case for outperformance.
Germany’s manufacturing exposure is the highest among EMU countries and is currently benefitting from strong auto export demand
Source: OECD, World Bank, Datastream, MSIM. Data as of 1 September 2020.
However, there are a number of key risks to Germany’s recovery, the biggest of which is its reliance on external demand, which could be jeopardised by a hard Brexit, renewed trade tensions between the US and China and a slower global recovery due to persistent surges in COVID-19 cases across many US states. During the two-day pullback the DAX was down 3%5 however, this is a position which we believe should play out positively in the long term. Indeed, on the trading day following the pullback, the DAX partially recovered and was up 2%6.
On 20 August for portfolios that permit it, we added to our position in global renewable energy, which we first initiated on 20 July 2020. This was based on our continued conviction of this sector’s exposure to positive structural growth trends, which are increasingly being supported by both government policy and economic incentives to invest in clean energy.
1 Bloomberg, as of 4 September 2020.
2 Bloomberg, 3 and 4 September 2020.
3 EU Commission. www.ec.europa.eu/info/live-work-travel-eu/health/coronavirus-response/recovery-plan-europe_en
4 Source: GS, Europe on track for outperformance.
5 Bloomberg, over 3 and 4 September 2020.
6 Bloomberg, one day return, as of 7 September 2020.
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