In terms of performance, 2019 was undoubtedly a good year – both for equity indices and R-co Valor. However, 2018’s figures also need to be taken into account as markets do not behave on a calendar year basis.

Yoann Ignatiew and Charles-Edouard Bilbault, Co-Fund Manager, Rothschild & Co Asset Management

This past year revealed a notable deceleration in economic growth, globally reaching 2.9 percent compared with 3.7 percent the year prior driven by sustained momentum in Asia. Recession risks seem to be fading as macroeconomic data stabilize, signaling a potential recovery. Nevertheless, investor sentiment remains paramount for a rebound in economic activity.

In this respect, the latest progress in U.S./China trade discussions should provide a breath of fresh air for investors and pave the way for a more sustained rebound, in particular, driven by a recovery in investment. Furthermore, 2019 should be put into perspective, illustrating a radically different situation from 2018 for risky assets.

Expansion in Valuation

As a matter of fact, equity indices recorded strong gains driven by an expansion in valuation multiples despite stagnating earnings, as opposed to the year prior. This trend reversal occurred as central banks moved back to more accommodative monetary policies with the announcement of further rate cuts.

The upheavals of the trade war continued to drive equity markets in May and August, although in a much narrower range than the ones observed in Q4 2018. The intervention of central banks and underinvestment in risky assets over the past two years pushed valuations higher throughout the year. In addition, the Sino-American trade dispute finally seems to be on the right path, as the two parties recently announced that a «phase one» deal was reached. This breakthrough led to the cancellation of further tariffs originally planned for December 15, 2019, an outcome that markets had, however, already partially priced in.

Additional Boost For Markets in 2020?

While profit growth for 2019 was difficult to predict, the comparable 2019-2020 period should be more straightforward, as analysts expect a growth rate of 8 percent to 9 percent. Conversely, it seems unlikely that 2020 will be as buoyant for equity indices as it was in 2019. However, slight gains can be expected both in Europe and in the US. Once again, interest rates and inflation need to be monitored closely. Finally, the decisive outcome of a trade agreement between China and the U.S. remains key.

It is worth noting that 2020 will be a distinctive year in the U.S., as it will be strongly influenced by the presidential election. Consequently, the Federal Reserve (Fed) is expected to stay on hold and maintain interest rates at current levels, unless unexpected events were to force them to make adjustments. The first notable event will take place on March 3, 2020, with the «Super Tuesday» primaries, which should provide a fairly clear picture of the next Democratic candidate.

Thereafter, the polls between the incumbent President and his nominated opponent will lead the way. Much like the Sino-U.S. trade war, this particular situation is likely to generate volatility in equity markets based on candidates, their announcements, and their impact on certain industries (healthcare, energy, finance, technology), notably from a regulatory perspective.

Technology Outperforms Despite Major Dispersion

The technology sector performed very well throughout the year, despite a notable lack of correlation between American and Chinese indices. The latter significantly underperformed, with strong dispersion between sub-sectors. Stocks significantly exposed to the trade war or other structural changes particularly suffered.

On the other hand, companies which we were exposed to, especially those linked to e-commerce, did particularly well as they were supported by persistent domestic demand and strong growth potential.

Recovery within Financials

The financial sector, which is closely tied to interest rate levels, gained momentum and was able to catch-up since the beginning of the summer as yields slightly increased.

The scale of buyback programs within the sector combined with significant profit redistributions has been particularly accretive for shareholders who are maintaining their positions.

Potential Within Industrials

We slightly increased our exposure to the industrial sector to consolidate the portfolio’s cyclical allocation. With that in mind, we strengthened our exposure to railways, after having strongly reduced it during the summer. These changes were driven by our analysis of macroeconomic dynamics, which, if not accelerating, are on the verge of stabilizing.

Although still too early to mention an inflection point, it appears that the recent slowdown may be coming to an end, and we are taking advantage of attractive valuations to slightly add to our exposure to the sector.

China’s Growth Drives Raw Materials

Raw materials are a sector in which we have not yet seen a real turnaround or even a real change over the cycle. Its development remains highly dependent on the dynamics of China’s growth, which is currently undergoing a structural slowdown.

Considering today’s geopolitical environment, this sector may experience a strong boost should the cycle rebound and depending on the U.S.-China trade outcome.

Profit-Taking in Gold Miners

We were particularly active in August on gold miners, which represent a very defensive component of the portfolio. We significantly reduced our exposure to the sector to make substantial profits. We nevertheless decided to maintain our positions in certain stocks, with a longer-term view.

This is a decorrelated asset with a particularly favorable supply-demand balance, which can act as a form of a safe haven. We may again increase our positions should the opportunity arise.

Healthcare, a Long-Term Defensive Theme

Still, within our defensive allocation, we maintained our exposure to the healthcare sector despite some intersectoral movements. We are conscious that this pocket is likely to come under pressure during the US election.

However, we maintain a favorable long-term view on this theme, driven in particular by innovation, FDA approvals’ dynamics, and the issue of an aging population...

Manage Risk and Seize Opportunities

Following these movements, Canada now represents our top allocation by country, with about 30 percent of our equity portfolio, neck, and neck with the U.S., Europe, and China are both at around 20 percent. R-co Valor’s flexible approach is essential to take advantage of idiosyncratic opportunities in an environment where valuations are generally not particularly attractive, but with dispersion between sectors.

These views are reflected in our current level of equity exposure – at around 70 percent of the fund’s net assets – its lowest level in the past ten years. Yet, equities remain our favorite asset class in this environment. As long as rates remain at these levels, corrections in equity markets will create opportunities that we are ready to jump on considering our relatively large cash allocation.

That said, given current market levels, it seems relatively daring to massively buy equities, especially after 2019’s performance. We currently find ourselves in «wait-and-see» mode and prefer showing patience.