Home | Our Views and Strategies | High Conviction Calls
Setting the Stage for Recovery: Early-risers or Late-bloomers?
For the next six months, investors should allocate more towards value-cyclical late-bloomers such as US Financial and European Equities. But do not discount the early-risers: Maintain exposure to Asia ex-Japan equities to tap on structural drivers, despite tighter liquidity, and look out for a possible rotation back to US quality growth equities as economic growth moderates towards end-2021.
As the global economy recovers and inflation rises, investors have been rotating out of “early-riser” growth sectors into “late-bloomer” value sectors that benefit from economic reopening. While growth sectors tend to lead when inflation is low but rising, value sectors overtake growth when inflation heats up (Figure C7).
Figure C7. Value and Growth sectors will take turns to lead when inflation is rising.
Source: Datastream, STOXX, Goldman Sachs Global Investment Research, February 2021. Sectors based on MSCI AC World indices. Average 3-month total return in local currency since 1997. High inflation is defined as >2.25%, while low inflation is <1.75%.
Early-risers, which include Asia ex-Japan equities and US growth equities, started rising in 2020 on expectations of a post-pandemic recovery. This initial momentum sees them further ahead in the recovery phase, making them less attractive investments now.
Poised to benefit from economic reopening, late-bloomers, which include US value equities and European equities, are still in the early stages of the recovery. Value-oriented and cyclical-driven sectors are the preferred tactical positions to focus on as economic growth continues.
Towards end-2021, a rotation back to growth sectors could happen as inflationary pressures ease and economic growth moderates. In view of this, investors should position their holdings to capture opportunities from late-bloomers now and be sufficiently nimble to tap on specific early-risers.
Late-bloomers Play Catch-Up
Value equities staged a strong comeback in H1 2021. As they are still trading at a discount, they have room to rise further. Rising yields due to recovering economic growth will support value equities.
European equities represent a convergence of themes. Traditionally associated with more value companies, there are quality companies within European equities that also have longer-term structural drivers.
Value equities still have room to rally
Value equities underperformed their growth peers last year when COVID-19 lockdowns affected businesses. Since then, the global progress on vaccinations has offered a path towards economic reopening. As late-bloomers, value equities have made up significant ground – having risen +17.6% since the start of the year.
With an estimated earnings growth of +44% for 2021, value equities can also benefit from the economic recovery driven by fiscal stimulus, improving business investment and recovering consumer spending.
Despite this year’s earlier rally, value equities are still trading at a discount (17.4x forward PE) to their growth counterparts (26.7x forward PE), making this an attractive entry point for investors seeking to capture opportunities in value equities.
Financials are the preferred cyclical investment strategy
Financials – which make up 21%10 of the US value equities index – will benefit as the cyclical theme plays out.
Banking stocks are expected to rise as yield curve steepening leads to widening interest margins and greater profitability (Figure C8). However, investors will need to pay attention to the US Federal Reserve’s interest rate stance on inflation and possible tightening. As the economy recovers, loan growth and lower bad debt provisions will also support banking stocks.
Brighter prospects are also in store for asset managers and insurers as better risk asset performance and stronger investor appetite boost their fee incomes.
Figure C8. Higher yields support earnings growth of banks.
Source: Bloomberg, as of 15 June 2021
Sectors to be aware of
Not every sector is attractive as the late-bloomers narrative plays out. For example, uncertain OPEC oil production quotas and the increasing focus on clean energy will cloud the earnings outlook for oil counters.
With reflation likely to moderate in H2 2021, it is best to avoid defensive sectors such as Consumer Staples and Utilities as dividend-paying stocks tend to underperform as yields rise.
Prefer Europe as key drivers present growth opportunities
Vaccine rollouts will drive economic recovery in regions such as Europe and Emerging Markets, supporting the performance of global value equities. These markets are likely to benefit more from a late-stage recovery as they have a greater proportion of cyclical sectors such as Financials, Industrials and Materials.
Despite the year-to-date rally, value equities should continue to perform well. Rising yields and strong growth expectations should drive the overall performance of value equities.
Opportunity is ripe for positioning in Europe as risks dissipate
An unsynchronised global economic recovery from COVID-19 sees the Eurozone lagging behind other developed countries. Political uncertainty also looms with the German and French elections in September 2021 and April 2022 respectively. These concerns may cloud, but not necessarily derail, Europe’s economic recovery.
Substantial fiscal and monetary stimuli have kickstarted Europe’s recovery from the pandemic, enabling economic reopening and releasing pent-up consumer demand. This will fuel a recovery in European corporate earnings (Figure C9).
Figure C9. A recovery in Eurozone growth drives regional corporate earnings.
Source: Eurostat, IBES, MSCI, Refinitiv Datastream, J.P. Morgan Asset Management. Nominal GDP forecasts from J.P. Morgan Securities Research. Data as of 24 May 2021.
The global economic recovery will also bolster European equities, given their cyclical nature and lower sensitivity to rising bond yields. Unlike their US counterparts which are tilted towards the IT and Communications sectors, European equities have greater exposure to cyclical industries such as Industrials, Materials and Financials.
As laggards, European equities are finally catching up and riding the cyclical recovery. Traditionally seen as value equities, the cyclical nature of European equities also provides an opportunity for investors to participate in the long-term structural growth story (Figure C10). Finding the right gems that embody this duality play of both the value and cyclical themes is key.
Figure C10. Value-oriented European companies can also participate in long-term structural growth.
Source: AllianzGI, AllianzGI Economics & Strategy, September 2020.
Early-risers Still Have A Runway Ahead
The ongoing global economic recovery and resumption of global trade will be positive for Asia ex-Japan equities despite these being early-risers. A mutually beneficial and maturing trade ecosystem within Asia makes the region less susceptible to risks from US and Europe.
As inflation eases and the global economic recovery moderates in late-2021, value stocks will rise at a slower rate. This could create a rotation back to growth sectors, particularly in US quality growth stocks.
Asia ex-Japan equities to benefit from strong growth in the region
Supported by a weakening USD and a pick-up in global trade, Asia is expected to be the fastest-growing region in 2021 with a forecasted GDP growth of 8.6%11. This is led by the Chinese and Indian economies, which are expected to grow 9.1% and 8.5% respectively in 202112.
Trade-oriented companies in China will gain from rising demand as the global economy recovers, despite tightening monetary and fiscal conditions domestically.
Ongoing US-China tensions will benefit Taiwan and South Korea, which continue to supply high-end semiconductors that both the US and China struggle to produce.
Despite talks of diversifying supply chains, companies do not want to lose access to China’s vast market: 82% of US firms13 want to continue maintaining a presence in China. Hence, other Asian countries may not benefit as much from reshoring away from China as previously thought, but this diminishes the risk of reshoring for China’s economic growth.
Over the longer term, Asia’s fast-growing middle class will act as a growth catalyst for the region. From 2020 to 2030, the middle class in India, China and the rest of Asia are expected to grow by 883 million, 453 million and 133 million respectively14, creating new demand for goods and services.
Asia’s burgeoning middle class will provide a natural market for China’s exports. Already, almost half of China’s exports head to Asian countries (Figure C11), overtaking exports to the US and Europe combined.
This interdependence between China and the rest of Asia creates a mini trade ecosystem which will generate growth within the region that is less sensitive to risks from the US and Europe.
Even in the short run, these developments will boost demand for Asia ex-Japan equities, which investors should continue to hold in their portfolio.
Figure C11. China relies heavily on Asia for its exports.
Source: UOB Global Economics and Markets Research, April 2021
Growth rotation turns the spotlight back to US quality growth stocks
As economic growth moderates and inflation pressures ease, the rotation back to growth will drive investors to the US market first. Home to many innovators and enablers, the US market accounts for 73% of global technology firms and will lure investors when the hunt for growth resumes.
However, investors should invest selectively in companies that can demonstrate lower leverage and consistent earnings growth over the long term to improve the quality of growth within investment portfolios.
As US valuations remain high with a forward PE of 21.3x, there is a possible risk that markets could overshoot on expectations of a strong Q2 2021 earnings season. Investors should be aware that high valuations come with a risk of a possible pull-back.
Investors have built in a reasonable equity risk premium to cushion against rising inflation and interest rates. In H2 2021, inflation is likely to taper off as the global economic recovery moderates. This may result in value stocks rising at a slower rate, creating a possible rotation back to growth stocks spurred by secular trends.
Early-risers are growth sectors that had initially rebounded during the early stage of the pandemic but have since underperformed as economies reopen. Conversely, late-bloomers are value-oriented sectors that had recently started to outperform.
For the next six months, investors should allocate more to late-bloomers, specifically value-cyclical equities such as US Financial and European Equities, over Energy and Commodity equities. However, maintain exposure to Asia ex-Japan equities – early risers – to tap on structural drivers, despite tighter liquidity.
The current environment may not be supportive for US growth equities now, but investors should look out for a possible rotation back to these sectors as economic growth moderates towards end-2021. (Figure C12).
Figure C12. Summary of High Conviction Calls.
10 S&P Dow Jones Indices, 28 May 2021
11 IMF World Economic Outlook, April 2021
12 UOB Global Economics and Markets Research, June 2021
13 FactSet, JPMorgan Asset Management, The American Chamber of Commerce in Shanghai. The survey was taken from 11 to 15 November 2020. Responses were received from 124 companies.
14 Brookings Institution, J.P. Morgan Asset Management, March 2021