18 December 2019

The rapid increase towards stock market highs continues in December, supported by Boris Johnson’s victory in the UK and signature of the initial phase of a trade deal between the US and China. 2019 draws to a close confirming its status as a year with two distinct sides: until the end of the summer the market grew through defensive and growth sectors; while from September onwards, cyclicals and value stocks took control. This inversion in a trend that had continued for numerous quarters is closely linked to a moderate increase in interest rates and is primarily due to three factors: (i) positive developments on the geopolitical and trade-war front; (ii) a turning point in macroeconomic data which seem to signal bottoming of the economic cycle; and (iii) the persistence with which a more expansive fiscal policy has been requested recently by various parties.

For 2020, Massimo Trabattoni, Head of Italian Equity, expects continuing outperformance of the cyclical component to be a key aspect. As introduced by Christine Lagarde during her initial period as President of the European Central Bank, monetary policy has exhausted tools to further support the economy. And this is why Lagarde instead proposes to reformulate fiscal stimulus with a more expansive approach. With the enormous structural investments (e.g. infrastructure) that are needed and the situation of certain Member States, such as Germany, which have a fiscal surplus, the solution to improve internal demand of the European Union must include greater public spending by those governments that can afford it. This narrative, together with an improvement in global macro data, is driving a slight recovery in interest rates and strengthens the positive sentiment around cyclical sectors such as industrials and construction.

It must not be thought however, that defensives, such as utilities and healthcare, have stopped performing completely. In fact, as long as interest rates remain so low, long-term investors looking for returns will continue to be marginal buyers of equities as long as they ensure high dividends and low volatility. According to Mr Trabattoni, greater selectivity will emerge in the choice of individual stocks, with preference for sub-sectors where there is still investment to be made and particular attention to ESG themes. More generally, this focus on thematic investments will be increasingly significant both in analysis of individual stocks, and because “themes” will replace traditional sectors and geographies as benchmarks against which to value companies in “relative” terms.

Considering Italy, there is good news from PIRs. In the context of the Budget Law, the government has approved an adjustment to PIR regulations that eliminates the requirement to invest 7% in companies listed on the AIM and unlisted companies (amendment made in 2018 that completely blocked investment), replacing it with the requirement to invest at least 3% in non-FTSE MIB and non-MIDEX companies. Despite the fact that the legislation comes into force in 2020, purchasing flows of small and mid caps have already been seen, particularly for those names most exposed to the cycle along with the economic recovery. On the large-cap front, banking is a sector that could see traction in 2020. As well as benefiting the recovery of cyclical/value assets, the two main specific catalysts in the sector are: (i) intra-national consolidation between medium-sized banks, now that a good portion of NPLs have left the system; and (ii) the possibility of a European banking union, which could represent a trigger for international M&A activity.

Exposure should be focused primarily towards companies with limited revenue derived from net interest margin and more from other sources.

Interview with Massimo Trabattoni, Head of Italian Equity.