Q1 2021 Equity Manager Report: Value the standout performer again
Four months into the new year, are value stocks still at the head of the pack?
The answer: A resounding yes.
Our newly released equity manager report shows that the first quarter of 2021 picked up where the last quarter of 2020 left off, with the rotation toward more cyclical areas of the market continuing as the COVID-19 vaccine rollout gathered pace. The value factor in particular was a standout performer across all regions, as economically sensitive areas of the market extended their recovery that began with the positive vaccine news last November. Meanwhile, the growth and momentum factors—last year’s strong performers—were the clear laggards as the market rotation picked up steam.
With greater clarity on the sustainability of the economic recovery, we also saw the opportunity set across markets broaden to include sectors beyond those seen as the primary beneficiaries of an economic reopening. This ultimately led to a favorable environment for active managers across most regions, including global equity, emerging markets, U.S. large cap, U.S. small cap, UK, Europe, Japan, Canada and Australia equity managers. On the other side of the ledger, the first quarter proved to be more challenging for real assets equity managers.
As expected, the recovery hasn’t been smooth sailing for all, with successful vaccine rollouts in the U.S. and UK offset by vaccine shortages,efficacy concerns and an increase in COVID-19 case counts in other parts of the globe. This has led to some variations in performance within particular equity regions, such as emerging markets, where increasing infection rates in Brazil and India have slowed the recovery in cyclicals.
Amid increasing expectations of a pick-up in global growth, the energy sector turned in the strongest performance of the quarter, with financials, industrials and materials also experiencing positive relative returns. Conversely, the healthcare, tech and consumer staples sectors lagged.
While conviction in many growth-related names remains intact, managers are clearly being more selective, favoring those with stronger balance sheets and long-term prospects, and expressing more caution around valuations. Given the rapid recovery of certain cyclical and reopening trades, investors with greater valuation discipline are giving similar scrutiny to recent outperformers, assessing which stocks will continue to benefit from reopenings and when changes in positioning may be needed. With the ongoing stimulus from major central banks, more managers are also discussing the potential for inflation, although most remain sanguine for now.
Drawing on our distinctive relationship with underlying managers, our report is a compilation of the unique, forward-looking insights from specialists across the manager universe. Below, we list the chief tactical observations from key equity and geographic regions around the globe from the first quarter of 2021.
Positive outlook, long cyclicality
- Managers are positive on the outlook for the Australian and global economy, and are maintaining their overweights to materials, industrials and energy—which they expect to benefit from increased economic activity.
More confidence on banks
- Managers continue to be positive on banks despite valuation gains over the quarter. They are expecting write-backs of COVID-19 provisions, and believe banks will benefit from the improving economy and Australia’s rising housing market.
EVs support lithium and rare earth miners
- Continued electric-vehicle (EV) demand is leading to support for lithium and rare earth stocks. China-U.S. trade tensions could potentially create supply disruption, leading to price appreciation.
- Diversified miners are preferred, as iron ore prices are at risk with Brazilian production coming back online.
Bullish sentiment on oil companies
- Value managers continue to lean into the reopening trade, with positive views on oil stocks and continued preference for more cyclically oriented exploration and production (E&P) names. Dividend managers continue to favor stable and higher yielding pipelines.
COVID-19 to benefit incumbents
- As government lockdowns left smaller businesses in shambles, growth-at-a-reasonable-price (GARP) managers are sticking with established players with quality balance sheets and pandemic-proof business models for downside protection.
Outlook remains positive for financials
- Managers remain positive on financials (particularly asset managers and banks) as a continued economic recovery is expected. Managers cited potential dividend hikes and higher interest rates as support for the sector overall, while most remain reluctant on life insurance companies.
Emerging markets equities
Emerging markets (EM) recovery remains opportune for entry
- The reopening trade is still playing out, especially when compared to many developed-market countries, due to delays caused by the resurgence of COVID-19 in some countries. In particular, Brazil and India have been laggards, and remain opportune for a cyclical recovery to play out.
- The cyclical recovery continues to broaden, with managers also adding to banks, industrials, materials and consumer sectors.
Impact of higher U.S. inflation and rate expectations
- Managers are generally sanguine on inflation, as it would indicate healthy global trade, benefitting EM, e.g., exporters, commodity driven economies and financials. Reflationary trade is attractive in energy and miners (e.g. gold, copper, lithium and platinum group metals).
- Higher rates and U.S. dollar strength are a future tail risk for weaker economies. Managers are cautious on carry trade currencies, such as the Indonesian rupiah, as well as potential policy mistakes, e.g., monetary policy in Turkey.
Europe and UK equities
UK remains an opportunity
- Despite strong performance on the back of the successful vaccination rollout, valuations still remain attractive versus other regions.
Momentum in value is picking up
- The intersection of momentum and value is increasing, which provides further support for an ongoing value recovery.
- At the same time, there has been an increase in turnover at some deeper value managers as they become more selective around valuations and opportunities.
UK and European IPOs and mergers and acquisitions continue to thrive
- There has been an uptick in initial publication offering (IPO) activity. Some managers are looking at these as the new structural growth stories, with more traditional growth stocks being at stretched valuations or being sold to private equity.
Global and international equities
Cyclicals starting to discount higher margins
- Some managers are trimming, but still-rising demand and right-sized cost models are keeping others positive on the outlook.
Electric vehicles still fully charged
- Managers are enthusiastic about a rising number of credible EV suppliers—and the resultant demand trends for semiconductors.
Pharmaceuticals and consumer staples ready for rotation
- Managers are easing into defensives based on relative valuation. Value managers see big pharma as attractive.
Quant mangers repositioning following a tough period
- Some managers are backing away from factor bets and lowering return targets in a bid to correct returns and reset expectations.
Will the herd follow the vaccinations?
- The U.S. jumped to an early lead on vaccines and recovery, but some now see better opportunities in lagging markets.
Growth managers reducing crowded trades
- Managers are reducing positions in expensive growth stocks, which are looking less attractive with the rise in U.S. interest rates. Otherwise, the majority have not changed the overall shape of their portfolios, expecting the value rally to be short-lived.
Value managers gradually shifting to defensive values
- Value managers are trimming cyclicals, which rebounded strongly, and are rotating to defensive value laggards. Overall, managers expect continuous rerating for value stocks, due to the cheap valuation and improving earnings momentum.
Cyclical recovery supportive of Japan equities
- Japan’s relatively high exposure to the manufacturing sector should benefit from the continued cyclical recovery.
Slow vaccination rollout presents opportunity
- The reopening trade in Japan is lagging other markets, such as the U.S., and therefore presents potential relative opportunity as the situation improves.
Real assets equities
- E-commerce continues to drive strong demand for logistics.
- Supply-chain configuration resilience from onshoring and inventory is driving further demand.
- The outlook in senior housing is improving as occupancy declines stabilize. The sector is also benefiting from future demographic trends and a needs-based fundamental profile.
- Strong demand and record occupancy in the storage sector are providing unprecedented pricing power to landlords, further supported by supply headwinds.
- Utilities that are transitioning to renewable energy remain attractive, especially in Europe, while rising interest rates in North America make it a more challenging environment.
- Because rising costs due to inflation can be passed on to consumers, toll roads and airports (with rate escalators) remain attractive opportunities.
U.S. large cap equities
Managers continue to favor a cyclical recovery scenario, albeit less of a rising-tide-lifts-all-boats version
- While the interest rate environment has improved and most managers expect continuing inflation for the near-term, banks are a favored industry within financials. In addition to improving net interest margins, many banks have also improved their profitability, which will drive continued earnings growth.
- As consumer-sensitive stocks have generally benefited from the reopening trade, investors are assessing which stocks within the reopening theme are likely to have stronger fundamentals. Examples of this include favoring airlines over cruise lines in the travel sector.
- Managers used the selloff in growth tech stocks to add to stocks exposed to corporate IT (information-technology) spend, seeing growth in cloud-based computing as a continuing trend post-COVID.
U.S. small cap equities
Growth managers buying into recent tech selloff
- Growth managers are taking advantage of the recent selloff in long-duration tech stocks, but are being selective in buying higher quality names with relatively longer histories.
Relative value managers peeling back cyclical exposure
- While most value managers agree that the U.S. economic recovery is still in an early phase, relative value managers believe valuations for the most cyclical sectors and the reopening trade are now priced for perfection, and are consequently reducing exposure.
SPACs raise over $100 billion in 2021 YTD vs. $83 billion in 2020
- After an initially skeptical view on SPACs (special purpose acquisition companies), managers are now opportunistically thinking of investing in a few SPACs, especially given the recent tech selloff. They have expressed openness to both pre-deal announced SPACs as well as those where deals have been announced but not yet closed.
The bottom line
As the global vaccine rollout and broader economic reopening continues, we expect the market rotation toward cyclical and value stocks to follow suit. However, as the first quarter of the year has already demonstrated, the economic recovery is likely to be uneven as efforts to tame the virus and lift restrictions vary across the globe. Ultimately, we believe this should lead to a staggered reopening of economies, creating volatility and opportunity. In such an environment, the views of specialist managers will be paramount to exploiting both. We look forward to continuing to share these insights with you as the world slowly emerges from the other side of the pandemic.