Fund update | R-co Conviction Equity Value Euro
Market trends
Anthony Bailly & Vincent Imeneuraët, European Equities Fund Managers Rothschild & Co Asset Management.
Financial markets continued to decline in September, as they had since the second half of August, against a backdrop of ongoing tightening in central bank monetary policies. The MSCI World fell by 6.9% and the S&P 500 by 6.8% (in dollars). Meanwhile, the EuroStoxx with dividends reinvested turned in its seventh monthly decline on the year, this time by 6.2% (1).
Inflation obviously remained the main topic, especially in Europe, where it crossed the 10% threshold (vs. 9.1% in August and forecasts of 9.7%)(1). Driven by an especially poor number in Germany (10.9% vs. 8.8% in August)(1), inflation does indeed seem to be spreading throughout the economy, in spite of government measures to rein in energy prices. In fact, it has been so persistent that the ECB put through a 75 basis point (bps) rate hike (with its deposit rate now at 0.75%), thus matching its deeds to Christine Lagarde’s hawkish words(2) since Jackson Hole. The ECB also raised its inflation forecasts (to 5.5% in 2023 and 2.3% in 2024)(3), and lowered its growth projections (to +0.9% for 2023, followed by a rebound to 1.9% in 2024)(3). The Eurozone PMI(4) composite index fell for the fifth consecutive month, this time from 48.9 to 48.1(5). Also in Europe, the BoE(6) did put through a 50 bps rate hike but was forced to postpone its balance-sheet reduction plan and restart its government bond buying programme after the market turmoil set off by Liz Truss’s announcement of a debt-financed stimulus plan. Last but not least, at the gates of Europe, concerns remain over a possible escalation of the situation in Ukraine following the annexation referendums held late last month. The Ukrainian forces’ recent counterattack and the ever more threatening line taken by Vladimir do not seem to point to a resolution any time soon to the conflict.
In the US, inflation did recede (to 8.3% in August vs. 8.5% in July and 8.1% forecast)(1), but core inflation picked back up (to 6.3% in August vs. 5.9% in July)(1), reviving market fears and undermining the narrative that inflation had already peaked. Job creations are still robust (315,000 vs. 298,000 forecast)(1), showing that the labour market is still tight and stoking fears that inflation will continue via a wage-price spiral. In reaction, and as expected, the Fed reiterated its determination to bring inflation to a head through a third consecutive 75 bps rate hike.
However, what wasn’t expected was the Fed’s hawkish line, with its forecasts(7) of key rates that were beyond market expectations, at, respectively, 4.4% for the end of 2022 and 4.6% for the end of 2023. In China, the economic recovery is taking its time and is being held back by the zero-Covid policy. Retail sales and manufacturing output expanded, respectively, by 5.4% and 4.2% year-on-year, but September PMI indicators fell short of expectations. The manufacturing indicator rose only slightly (from 49.4 to 50.1), while the non-manufacturing number actually fell (from 52.6 to 50.6), as did the Caixin (from 49.5 to 48.1(8).
Interest rates rose especially sharply in September, driven mainly by real rates, and this contributed to a de-rating on the equity markets. The 10-year US yield rose by 64 bps (including 96 bps in real rates), the 10-year UK rate by 128 bps (147 bps in real rates), and the Bund(9) by 57bp (80 bps in real rates)(10). These shifts also had a heavy impact on currencies, with sterling dropping by 1.5% vs. the euro and by 4% vs. the dollar(10), and with the Bank of Japan’s first forex market intervention since the Asian crisis in 1998.
Bad news is also beginning to show up on the microeconomic level, with no fewer than 30 profit-warnings(11) in Europe in September. These have been caused by various factors, including weaker volumes (Fedex and Colruyt, for example), higher costs (Dow Chemical, AB Foods and Kion), and bottlenecks (Ocado and Telenor)(12). The inflationary environment that has now lasted for several months is beginning to feed through directly and indirectly into companies’ guidance. Earnings per share (EPS) forecasts for 2022 on the Stoxx 600 have been revised slightly lower (to +18.5% vs. 18.8% the previous month, and to +5.0% ex-commodities vs. 5.8%), while forecasts for 2023 have been raised marginally (to 3.3% vs. +2.9% and to +10.2% ex-commodities vs. +9.7%)(13). This suggests an uneven landscape, something that company managers will probably confirm during third-quarter reporting season.
Fund performance & positioning
In this challenging market context, R-co Conviction Equity Value lost 6.8% on the month, almost as much as its benchmark(14)(-6.2%), thus shrinking its year-to-date outperformance to +0.7%(15). While the fund’s sector allocation provided a boost, particularly in its overweighting of banks (the month’s top sector at -0.8%), it also took a hit from its stock-picking, with the marked decline of some of our stocks during the month including Faurecia (-21.9%), Alstom (-18,6%), and Carrefour (-14.6%)(16).
For the same reasons as in the two previous months – i.e., a further slide in soft data(17), stubborn inflation, and ongoing energy uncertainties in Europe – we have still not sought to ramp up the portfolio’s cyclical profile. These factors continue to undermine the macroeconomic outlook, particularly in Europe, and we reiterate our cautious take on the economic environment for the weeks and months to come.
That being said, on a market that has just experienced its worst monthly performance and with a recession looking more likely than ever, cyclical stocks’ relative valuations vs. defensives have not budged from the historic low they reached last month. For example, like telecoms (-11.2% in September)(16), some defensive sectors underperformed the market on the month, while others merely performed in line with it, such as Healthcare and Utilities (-6.8%)(16). This reinforces our view that the market has already priced in a moderate recession. For the moment, we have held onto the more conservative stance we have taken on the fund since June. If PMI indices continue to worsen and if, as we expect, downward revisions in EPS forecasts come to pass, we will soon be tempted to reinvest in certain hard-hit cyclical stocks that offer attractive entry points on a medium- to long-term horizon.
With this in mind, we are keeping a close eye on the Autos sector. True, it once again underperformed the market (-7.7% on the month of September)(16), but its volumes are recovering rapidly as supply-chain issues are resolved. The sector’s year-to-date underperformance (-25%)(16), the very poor outlook being priced into deeply discounted valuations, and key markets that offer considerable potential for rebound even in a recession – the US market has shrunk by 26% since May 2021 and the European market by 35% from its peak in August 2018(18) – suggest to us that the sector is close to bottoming out.
Meanwhile, we still have a very constructive view of banks and energy for two reasons:
1. the two sectors’ valuations are among the most attractive;
2. their earnings growth outlooks are still looking good, due to higher interest rates for banks and sustained high oil & gas prices (albeit with a recent dip) in the case of energy (see OPEC’s(19) recent output cuts).
Meanwhile, in a geopolitical context that remains highly tense, energy continues to offer – for once, in our view – defensive features.
As for portfolio adjustments, we sought to diversify our banking exposure while continuing to overweight the sector by just as much. We did so by bringing Bankinter into the portfolio, due to its interest-rate sensitivity and the ability it has demonstrated in previous crises to limit its cost of risk. This helped us readjust our risk profile. We set up this position, among other things, by taking some profits on Caixabank (up by 44% on the year to date)(20), and by dialling back our bets on the Italian banks Intesa and Unicredit, which have thus far shrugged off the Italian election results. In addition, we added to our cyclical positions that were hit hardest during the month, including Saint-Gobain, Technip Energies, Faurecia and Alstom, in order to limit their dilution by buying into weakness that we felt was overdone. However, we have made only small moves so far.
Press Contacts :
Gunther De Backer
Olivier Duquaine