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Sharpe Thinking: are fundamentals reasserting themselves?

What’s moving the investment landscape? In these turbulent markets, we bring you views from our portfolio managers, analysts and economists, delivered by our Investment Office – an independent body ensuring that our investment teams perform in the best interest of clients.

As markets emerge from a heady summer, volatility has started to rear its head again amid an influx of news relating to Brexit and the US presidential election. Persistent support for technology stocks has helped to create more dispersion in how styles and regions have performed, as growth continues to outperform value and the tech-heavy NASDAQ and other US markets surge ahead of the more traditional European indices.

Our Multi Asset team thinks that this political chatter has caused the market to be hijacked by technical factors, pointing to the US 30-year Treasury bond yield as an example. As the 30-year yield increases, its relative appeal as a source of yield may drain some capital away from asset classes like equities and bring an end to some of the recent exuberance.

The idea that rates could be driven higher is also emphasised by our Economics team, which points to Chinese demand for US Treasuries (these currently account for 17% of its international holdings). As US-China trade talks continue, the team is closely watching for any change in China’s commitment to these assets, which could, if it shifts, have a knock-on effect on rates.

Equities: a new paradigm?

European equity markets have been slightly more resilient in recent weeks, in part because they are less correlated with the sentiment surrounding technology stocks. Nonetheless, our European Equity team believes the region is poised to benefit from the transformative change wrought by the pandemic.

As the digital revolution continues apace, the team notes increased demand for data providers and cloud solutions, which has boosted semiconductor-manufacturing firms that supply components which enhance bandwidth.  Our new cash-free reality is also boon for payment processors, while threats to supply chains have resulted in an increase in demand for technology that can assist with streamlining and refining supply-chain functions.

In a similar vein, Our Impact Opportunities team has found plenty of opportunities relating to the complex fall-out from shifts to telemedicine and a heightened focus on wellness. In particular, it sees the potential to seek out companies that are supporting the treatment of chronic, non-communicable, diseases such as diabetes, as well as growth areas like plasma therapy and dental implants.

Companies that focus on society’s unmet needs and which have strong balance sheets have also retained their market position throughout the recent turmoil.  Investors are in tune with this, shown by how demand for ESG strategies has persisted in recent months – indeed, assets under management in impact strategies have risen from $502-715bn over the past year.  

Credit: looking for nuances   

Our Credit team remains cautious, wary of some of the short-term exuberance that has been triggered by earnings-upside surprises in recent weeks. Firms are still hesitant when it comes to share buybacks, capital expenditure and dividends – although this prudence will, in time, improve the fundamental picture.  

Such an environment emphasises the need to look beyond the headlines and carry out bottom-up, fundamental analysis. In particular, a detailed analysis of the steel sector provides an indication of why performance in the industry has defied expectations. China’s v-shaped recovery has improved the global demand picture – despite demand remaining slack in Europe – and government aid has helped producers shift some of their fixed costs to variable ones. The fact that construction has continued largely uninterrupted has shored up demand for long steel and has helped protect Q2 earnings.

Our credit analysts also believe that valuations in the homebuilding sector are not currently in line with fundamentals – perhaps due to the industry’s complexity. In a similar vein, the team thinks that the structured-credit market offers an attractive complexity premium, along with low correlation to other markets and an enduring diversification benefit. 

Real estate: a return to normal?  

There is considerable dispersion within real estate, both between sectors – where the industrial market has performed well and retail has lagged – and public and private markets, where publicly listed property is trading at a far wider discount.

Our Real Estate team expects more liquidity to come back to the market as the number of trades is likely to rise in the coming months, particularly in the retail sector. A sense of normalisation is also apparent in the office sector, as large numbers of professionals consider returning to the office and the nature of how office space is used is reimagined.

For information purposes only. This is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Figures, unless otherwise indicated, are sourced from Federated Hermes.

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