The rising political tensions between the US and China are also clearly creating additional risks for many companies operating globally—that investors need to be mindful of. We may see new competition as China is encouraged to localize more of its technology. Many companies may also be exposed to higher costs from supply-chain de-globalization. US companies may face increased risks from retaliatory action by China aimed at cutting off its consumer from US companies. Ultimately, companies with significant exposure may require higher risk premiums in their valuations. That being said, retail-sales data from China appears to show a move from the recovery phase to expansion, and the healthy economic activity is reflective of the proactive response by the government to the COVID-19 pandemic.
As gloomy as the overall short-term economic picture clearly is, we are keen not to lose sight of the fact that COVID-19 will eventually pass, and that business and consumer confidence will eventually recover, bolstered by unprecedented levels of monetary and fiscal support. Additional waves of COVID-19 are likely to be less economically disruptive. Governments around the world are now better prepared and likely to take pre-emptive measures to avoid additional lockdowns. Test-and-trace systems are up and running in many parts of the world, and there is greater optimism since several effective vaccines are now being administered.
Opportunities Emerging in Some “Unloved” Areas
While the technology sector is likely to retain its leadership in terms of growth, we expect this leadership to broaden out with healthcare and industrials gaining as the global economic recovery gathers pace. Financials, conversely, may continue to struggle amid low rates and rising credit losses. While the sector faces challenges in aggregate, there remain many attractive opportunities for selective investors. There are a number of well-capitalized, high-quality international financial franchises that are seeing lower-than-expected losses, showing profit improvements in their overall businesses, and still trading well below their book value, offering compelling opportunities for long-term investors.
European risk assets2 have continued to benefit from the recent Euro-currency appreciation and fiscal support from the €750bn EU Recovery Fund. More importantly, this burden-sharing structure marks a landmark moment for the region, taking another step toward fiscal consolidation. Much of the stimulus will be focused on “green” initiatives and digitalization in Europe. In fact, nearly 30% of this stimulus will be focused on climate investment through further investment in renewables and utilities infrastructure. Late last year Europe announced its Green Deal, which is expected to translate into €7 trillion in investments to target net-zero carbon emissions by 2050. Utilities could account for nearly half of that and kick off an era of earnings growth and regulatory stability within the sector. Amid a government-mandated and Europe-wide commitment to rebuilding the power infrastructure, many European utilities are looking attractive from a growth perspective for the first time in decades.
Many governments have also discovered a clear alignment between the need for investment programs to stimulate growth and their ambition to accelerate the transition away from fossil fuels. The European Union, in particular, has focused its recovery plan on renewable energy, upgrading building stock, and accelerating the transition to electric vehicles. We have attempted to position our portfolios well for all of these trends and are optimistic that this period of change and innovation could remain a robust environment for fundamental active management.
It’s also worth mentioning that the impact of the virus in some cases may be lasting. The many unexpected outcomes of lockdowns, social distancing, and remote working may hasten the demise of established businesses in some areas (for example in travel, business interaction, retailing, etc.). It may also strengthen new business models in others, such as video communications, data centers and cloud service, e-commerce, and sports, as we adjust to a new way of living and working. We remain focused on watching for potential market dislocations and carefully weighing the trade-offs between risk and reward as we assess opportunities for unanticipated growth.
Capitalizing on Opportunities Through a High-Conviction Selective Approach
With “value traps” in disrupted industries lurking at one end of the spectrum and quality growth franchises that may already be priced for perfection lurking at the other, this invariably remains an attractive environment for active stock-picking. The market’s fixation on the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google’s parent company, Alphabet) and US-dollar strength of the past nine years has led many to overlook the great stock opportunities outside of the US. In fact, the majority of the best-performing stocks over the last five years has come from outside of the US and spread out across a wide range of industries, whereas the best-performing US stocks have nearly all come from the tech sector.3 The substantially greater market breadth within the international-equities investable universe would certainly argue for greater inefficiency and alpha4 opportunities for active investors. We remain in a period of heightened volatility, with huge variability in consensus earnings estimates and many companies reluctant to provide guidance. We are arguably in a golden period for active management within international equities and believe investors are best served by a high-conviction selective approach.