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International Equity Strategy Commentary - Q3/2020

International equity markets continued to recover in the third quarter as restrictions were eased after the Covid lockdowns of Q2. Hopes of a V-shaped global recovery in activity were boosted by better economic data. The EAFE index rose 1.30% in local currency terms and 4.88% in US dollars. Materials was the best performing sector again, rising 10.88%, whilst energy was the worst, falling another 13.18% despite the oil price being virtually unchanged.

Our liquidity analysis anticipated the rebound in global activity and continues to signal economic strength out to Q2 2021. The scale of monetary and fiscal expansion is unprecedented in peacetime and now coincides with an upswing in the stockbuilding cycle. This largesse by the monetary authorities should ensure a mixture of higher asset prices, a rise in goods and services inflation and strong economic growth. Global new cases of Covid were easing off in early October, whilst the European “second wave” – exaggerated in the data by increased testing – appeared to be peaking. Our analysis assumes that virus disruption will continue to wane, reflecting better targeted control measures, medical advances and a falling susceptible share of the population.

President Trump catching the virus briefly disrupted the US presidential election campaign. Democrat candidate Joe Biden leads comfortably in the polls but so did Hillary Clinton at this stage in 2016. If the Democrats win the White House and the Senate price controls on drugs and tax rises become more likely but investors are inclined to focus on the additional fiscal spending boost to the economy for now.

In Europe, Germany is the current president of the EU and is facing a long list of policy issues on top of Covid; relations with Russia and Belarus, China and a potential second Trump presidency, tensions between Greece and Turkey and the ongoing migrant issue. The UK would like to think its trade talks were an important issue as the clock ticks down on its negotiations with the EU. The Covid crisis has probably increased the chances of a last minute agreement that all concerned can spin as a victory to their local electorates. However, the chances of a no deal remain high and we are focused on any opportunities that might arise to reduce our underweight position, if the UK market and sterling sell off on no agreement being reached.

In Japan, Prime Minister Abe has resigned because of ill health and been replaced by Yoshihide Suga who faces a challenging economic backdrop, with gross domestic product falling 28% in Q2 and Q3 data suggesting a weaker recovery than elsewhere. His major policy proposals include establishing a digital agency, raising the minimum wage, lowering mobile phone fees and regional revitalisation. Elsewhere in Asia, China narrow money acceleration has been accompanied by an easing of credit conditions, reflected in the corporate financing component of the Cheung Kong Graduate School of Business (CKGSB) survey of private firms. Credit conditions tightened sharply after April 2019 as regional banks faced funding difficulties and restricted loan supply, with a knock-on negative impact on economic activity and narrow money demand. The strong rebound in the CKGSB index supports economic optimism and suggests a further rise in six-month true M1 growth.

The strong momentum of growth stocks versus value has continued favouring our emphasis on companies generating high or improving returns. Tracking errors have risen across equity mandates in 2020 reflecting not just the volatility in markets but also the significant differential in performance between factors. The contribution to tracking error from stocks has fallen as a percentage as the influence of factors has risen, most notably yield and value which have significantly underperformed. While it may be desirable to reduce tracking error after a period of substantial outperformance we do not intend to compromise our stock discipline by buying companies with poor economic value added metrics.

Transactions were again focused on taking profits in quality defensive areas and adding to more cyclical stocks that we like but have suffered in the Covid-19 correction. We have added to emerging markets and reduced Europe and Japan. We have reduced the underweight in healthcare and added to the overweight in IT. We have moved underweight real estate and increased industrials. Stock and sector selection were both positive. The zero weight in energy added value whilst stock picks outperformed in all but one sector.

The Composite rose 10.91% (10.71% Net) versus a 4.80% gain for the benchmark.

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