MARKET SITUATION
Equity markets have been falling since February 21. For the Standard and Poor's 500 index, this is the fastest entry into the bear market, down 20% from the peak in just 16 days, compared with more than 100 days on average in the 13 previous similar events since the turn of the century.
Unlike 2008, the current crisis is not a financial crisis. It is the result of a pandemic that is affecting the real economy. This is why the Monetary Authorities have first sought to support businesses and the banking sector by lowering interest rates, where possible, or through quantitative easing measures. More recently, the containment of many European countries requires public intervention to support demand. Massive stimulus plans are being implemented worldwide, even in the form of what is known as the " helicopter money", i.e. a distribution of income directly to households.
Although the spread of the virus throughout the world requires strong measures in proportion to the shock, there is evidence that markets are concerned about public deficits, leading to higher rates in “core” countries. What’s more, spreads on peripheral countries widen as spreads on corporate bonds widen, adding financial risk to the weakness of the real economy.
It is therefore up to the political Authorities, particularly in the Eurozone and particularly in Germany, to reassure the markets that they are determined to once again reiterate the "whatever it takes" in monetary terms with the "whatever it costs" in budgetary terms. The market downturn was initially concentrated on the most cyclical and financial segments. It is now also affecting growth stocks, which are suffering from rising interest rates and investors' withdrawal from the equity markets, in addition to the reduction in the positions of systematic funds, particularly those with volatility targets that are difficult to meet in the current context, where the volatility of the S&P500 has reduced the historical peak of 2008 to 80%.
It is clear that the sequence of these negative signals is having a considerable impact on investor morale. Nonetheless, certain factors must be kept in mind.
In view of the measures taken, and based on the evolution of the virus in other countries that have implemented strong measures, sometimes earlier, we should approach the inflection point of the number of cases affected by the virus in Italy. The decline in the markets, which brings the Eurostoxx 50 back to the "post Lehman" level, or even to the levels of 2002 or mid-1997, reflects a massive decline in expected earnings and an implicit discount rate.
STRATEGY UPDATE ON R-CO CONVICTION CLUB AND R-CO CONVICTION EQUITY VALUE EURO
R-Co Conviction Club
R-Co Conviction Club currently has an equity exposure level of around 70%, stable compared to the level at the beginning of the year. Its performance was affected by the high exposure to equities, particularly on cyclical and financial components which suffered from concerns about the cycle and record revisions made to the business and earnings growth outlook. In this period of severe turbulence, we bought back equities, our central scenario remaining that of an economic recovery after a significant but temporary shock to activity.
We have therefore:
- Bought futures on the DJ Eurostoxx 50 index in the face of the general sell-off.
- Opportunistically strengthened some stocks that posted significant declines
- Maintained bond sensitivity levels at around -1 across the portfolio, with German 10-year yields reaching extreme levels at -0.85% on March 9.
- We did not add credit risk.
Although the timing remains difficult to determine, we believe the portfolio is well positioned to benefit from the equity rally when the pandemic risk shows signs of stabilizing.
R-co Conviction Equity Value Euro
R-Co Conviction Equity Value Euro was penalized by its “value” style and its exposure to cyclical and financial stocks.
We made several adjustments to the fund to take advantage of opportunities that arose on certain stocks with strong balance sheets, which were severely punished indiscriminately by investors, like Peugeot, which we strengthened.
We also disposed of cyclical stocks that had performed well in the recent period, such as ST Microelectronics, for example. We reused the proceeds of these sales to overexpose ourselves to the energy sector via Total, which was particularly affected by the drop in oil prices, even though the balance sheet appears healthy, the dividend has been preserved and, although oil supply is under pressure, demand should pick up again once the health crisis is over.
European markets are trading on a 12-month P/E of 10.8x versus a long-term average of 14.5x, which corresponds to an implicit drop in earnings growth expectations of 26% over the year 2020. This trend is even more pronounced for the lowest valued stocks.
Should we approach the low point, as technical indicators seem to indicate, the value segment that has been particularly attacked could benefit from the market rebound as we saw in March 2009.
Written on March 18, 2020
