Q2 2020 Equity Manager Report: Tech in the driver's seat
Is the tech-fueled rebound in equity markets beginning to expand to other sectors?
While there are some signs of a broadening in the recovery that began at the end of March, the market rebound continues to be primarily driven by stocks benefiting the most from trends toward digitization and e-commerce—shifts that have been accelerated by the coronavirus pandemic. The information technology and consumer discretionary sectors performed strongly across most regions during the second quarter of 2020, with materials also charting a strong recovery. Meanwhile, defensive sectors such as consumer staples and utilities struggled during the quarter, as well as financials.
With broad acceptance that markets had indiscriminately sold-off—in addition to significant global fiscal and monetary stimulus and the widespread easing of lockdowns—the second quarter was marked by a strong market rally. This resulted in significant positive absolute returns across most equity markets.
On balance, the quarter presented a challenging environment for Canada, U.S. large cap and global equity managers, while proving more favorable for emerging markets, Europe, UK, Japan, U.S. small cap and Australia equity managers. The continuing narrowness of market leadership in the U.S.—where a small group of tech-heavy stocks dominated market returns—made it more difficult for managers to participate.
Growth managers have largely maintained positions in the big technology and consumer companies. Meanwhile, value managers continue to point to extreme valuation dispersions and rotate into attractive businesses with strong balance sheets trading at trough valuations.
Growth, momentum and—to a lesser extent—quality stocks continued to dominate performance across most regions during the second quarter. While there was a resurgence in value at the beginning of the quarter, this proved short-lived in many markets. Meanwhile, low volatility significantly underperformed other factors, as expected in such a risk-on environment.
Overall, despite the revival of animal spirits and a resurgence of risk appetite, uncertainties surrounding the economic and business impacts of coronavirus-related lockdowns, Brexit and the U.S. presidential election lie ahead. Many managers remain cautious in this regard as the second half of 2020 unfolds.
Amid these ongoing uncertainties, we believe there’s no better time than today to tap into the unique, forward-looking views provided by our distinctive relationship with underlying managers. This report shares the chief tactical observations from a wide range of specialists across key geographic and equity regions around the globe.
Maintaining a pro-cyclical tilt
- Managers are maintaining a positive tilt to sectors which benefit from increased economic activity, with an overweight to materials and energy being common. Managers are positive on the demand fundamentals for oil and iron ore, and note that Australian iron ore production has not been interrupted by COVID-19. Companies exposed to the Australian consumer are also in favor, as long as managers consider they are of sufficient quality.
Reducing the bank underweight
- Consistent with the positive cyclical view, managers are reducing their underweight to the Big Four banks. In addition to being highly leveraged to the Australian domestic economy, they believe the banks represent good value. Managers expect increases in bad debt expenses—but believe this is more than compensated for in the current prices.
Value managers shifting toward higher quality and defensiveness
- Value managers have been shifting their approaches to invest in stocks that have superior financial quality and defensive business models. Managers have favored relative value approaches versus traditional absolute value, and are also considering earnings and dividend growth potential versus dividend yield.
Growth managers emphasizing predictability
- As economic uncertainty persists, growth-oriented active managers have been taking profits in more cyclical growers that rebounded strongly in the second quarter, and repositioning toward stocks with more durable business models and earnings visibility. Managers have been shifting to stocks within the consumer discretionary sector that they believe are relatively less impacted by the COVID-19 crisis.
Emerging markets equities
Growth managers solidify thematic bets
- The recent lockdown accelerated the pace of disruption from cloud, e-commerce, payment and software companies, where managers added to long-term winners and new opportunities.
Value dislocations present value and quality opportunities
- Selectively, well-capitalized banks dipped close to Global Financial Crisis (GFC) valuation levels to present a strategic opportunity for value managers. Deep value investors rotated within energy toward lowest-cost producers such as Russia. Entry points also arose for quality managers investing into businesses with de-rated currencies, which opened attractive valuations.
Market-oriented managers cautiously optimistic
- Persistent COVID-19 concerns have seen slow normalization moves into tourism and cyclical growth areas. Managers also picked up on supply chain disruption benefiting Chinese substitutes and higher financial activity in Hong Kong stock re-listings.
Europe and UK equities
Expectation of V-shape recovery remains
- European industrial data is now pointing to a V-shape recovery. While investors are still concerned about a possible relapse in COVID-19, they are more constructive and believe fiscal impulses in Europe will surprise to the upside. This should benefit quality cyclicals as the market starts pricing in more benign global risk scenarios.
Brexit returned to the agenda
- As the deadline passed for an extension of the transition period—which expires on Dec. 31, 2020—Brexit risks returned and the UK materially lagged global markets. This has given rise to an increase in the relative attractive valuation opportunity in the UK market.
Global and international equities
Value substyles fall into distinct performance lanes
- Valuation spreads have illuminated the effect of substyle positioning even within the value universe. Defensive, yield-focused value lagged considerably during the second quarter. Conventional, deep value lagged standard indices, but there were bright spots among asset-backed plays. Materials exposure, especially to precious metals, has been beneficial year-to-date. Meanwhile, forward-looking or intrinsic value—which can include high cashflow-yielding tech—has had a tailwind.
No change of leadership: Pandemic favors online
- The market continues to bid up a narrow group of consumer and tech company beneficiaries. These continue to lead markets, and there are few signs of capitulation.
Autos, electric vehicles and Tesla polarize manager opinion
- Tesla has momentum, but value managers are backing the electric-vehicle model plans and the valuation of luxury auto makers.
Growth managers’ mixed message
- Some growth managers further reduced exposure to value-type companies to switch/add to positions in momentum growth stocks, while others trimmed stocks trading at stretched valuations.
Value managers adding cyclical exposures selectively
- During the second quarter, value managers reduced relative outperformers and switched into cyclical laggards. Due to concerns over a possible recession, they selectively increased positions in companies with stronger balance sheets and/or strong franchises.
Market-oriented managers kept trimming value exposures
- Many market-oriented managers maintained positions in quality growth stocks while continuing to trim positions in value stocks. While macro views were mixed, many managers believe it will take a longer time for value to outperform.
Real asset equities
Global property managers
- On a price-to-NAV (net asset value) basis, all regions are trading at significant discounts to NAV. Hong Kong and UK property companies are trading at the steepest discounts.
- Managers are tilting toward property sectors which are poised to benefit from ongoing restrictions, including rental housing, e-commerce beneficiaries and defensive/necessity-based sectors, while maintaining underweights to economically sensitive sectors and those with deteriorating fundamentals.
Global infrastructure managers
- North America energy production declines are becoming entrenched and impacting long-term demand in midstream energy.
- In utilities, the global decarbonization trend is leading to strong growth in wind, solar, battery storage and transmission investments.
U.S. large cap equities
Managers with a value philosophy going beyond traditional relative value approach
- Managers are identifying stock selection opportunities with:
- Idiosyncratic quality and defensiveness
- Underappreciated growth profiles
- Event-driven catalysts
- Within value industries, managers are seeking competitively advantaged stocks with superior profitability.
Growth-oriented managers seeing excellent stock selection opportunities in environment with clear secular trends
- Beyond the obvious growth trends of e-commerce and software, managers are seeing tremendous opportunities among stocks in traditional industries that have powerful digital capabilities and branding as well as robust online presences—allowing them to gain market share during the COVID-19 crisis.
- Managers expect improving sentiment in healthcare.
U.S. small cap equities
Growth managers keep their faith in technology
- Despite the technology sector’s strong run this year, growth managers have only marginally trimmed their exposure.
- Within the cyclical areas of the market, industrials remain the other overweight for growth managers, while they continue to be tactical in the consumer discretionary sector.
Value managers poised for economic recovery
- Value managers expect there to be pent-up demand once the economy opens up, and are seeking a combination of balance-sheet quality and attractive valuations. Deep value managers are adding to hard-hit areas such as airlines and restaurants, while relative value managers are finding more opportunities in industrials and materials.
Managers cautious on energy and financials
- Skepticism of energy stocks remains despite the second-quarter rebound. The same holds true for banks, due to headwinds on spreads and loan growth.
The bottom line
Equity markets clawed back a significant portion of their losses during a historic second-quarter rebound. However, the resurgence of the coronavirus in parts of the world, coupled with the upcoming U.S. elections and the looming end of the Brexit transition period, spells continued uncertainty in the months ahead.
During times like these, keeping a close watch on the views of specialist managers is crucial. As always, we’ll continue to keep you apprised of all the latest observations from across the manager universe.