Shifting from green and Chinese equities to US and Europe
- In our view, over the short term, Chinese equities offer limited potential. However, over the medium term, the twin engines of gentrification and digitalisation could prove to be strong catalysts
- Green stocks currently look expensive but the energy transition remains an important underlying trend that will shape at least the next decade
- Europe and the US look to likely to benefit from economic recovery and cyclical rotation
In November 2020, we upped our exposure to equities in general, notably Chinese shares and green stocks. However while we banked some profits in March this year, our long-term positive view on China and green assets remain intact. We expect to return to them, when we believe the time, and price, is right. Below we outline our key convictions on these investments.
Green stocks look expensive but remain an attractive investment in the medium term
The impact of the pandemic and subsequent collapse of growth last year led governments to implement very large fiscal stimulus plans, a substantial portion of which were dedicated to green initiatives tackling climate change. We had a basket of stocks made up of around 60 companies linked to the energy transition, which were set to benefit from this momentum.
Fundamentally, we believe the energy transition will involve considerable investment of circa US$1,000bn to $2,000bn per year in green infrastructure over the next decade, and companies exposed to the renewables theme should benefit. Within this area, we particularly like:
- The utilities sector, which receives a large share of its revenues from renewable energy
- Industrial companies producing electrical equipment
- Technology firms providing semiconductors to renewable energy firms
After reshuffling our selection by exiting stocks with a performance gain of more than 60%, we decided to sell our position and take profits. Despite the encouraging long-term growth prospects in this area, this decision can be explained in two ways. First, the negative impact of a potential sharp rise in interest rates, puts pressure on equity valuations linked to the energy transition. And second, in our experience, in an environment of rising rates growth stocks can be quite sensitive and can potentially underperform value stocks.
We will reposition ourselves in this sector when we think it is more appropriate to do so, but this will depend, particularly on the level of recovery in the US economy. The backdrop overheating, which seems to be taking shape in the short term with the return of inflation, could lead interest rates to rise and fuel the sector rotation of value versus growth stocks. As such, we are waiting for rates to stabilise before we to return to green stocks.
Chinese equities: Limited short-term potential but remain attractive in the medium term
After redirecting equity risk towards Asia, particularly China, which was showing better signs of resilience to the health crisis, we took profits on our tactical position as we believe that the upside potential for Chinese equities remains limited in the short term, following a tightening of monetary policy, which was aimed at containing the risk of debt and overheating in the property sector.
However, we are keeping Chinese equities in our long-term active selection and will reset this allocation when the believe the time is right. We still believe in the long-term outlook for the asset class, as China's continued gentrification remains a structural phenomenon that we see as supportive for domestic equities and many companies remain leaders in their markets – and indeed, in thematic sectors such as the digital economy.
Re-opening economies: Shifting to Europe and the US
To take advantage of the potential rotation from growth into value stocks, we are redirecting equity risk towards Europe and the US, in anticipation of the economic re-opening.
In the US, we have mainly focused on S&P 500 listed financials. However, in Europe, we are investing in bank stocks and the energy sector, both of which we believe are heavily discounted. Also, we have structured a basket focused on re-opening economies, as recovery should revive sectors such as hotels and aviation.
In the UK, where the vaccination campaign is ahead of the rest of Europe, we initiated a tactical position in cyclical domestic stocks, which we believe are attractively valued in the construction and catering sectors – as both suffered significantly in 2020. We have also invested in UK banks.
Looking ahead into 2021
This year is expected to be full of hope but it won’t be without obstacles. For now, we are maintaining our overweight to equities, which we believe currently offer more attractive return prospects than credit. But despite our natural focus on growth equities, we will aim to capitalise on the flexibility and adaptability of our approach, to capture market rotations and paradigm changes.
 Source: Goldman Sachs, Portfolio Strategy Research, The Green Theme - A Global Implementation, November 2020.
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