Non-U.S. equity markets staged a solid recovery from the lows seen in Q1. The sharp reversal in the second quarter was led by lower-quality and economically sensitive areas and stocks that had been expensive at the beginning of the period. Equity markets were driven mainly by massive global monetary and fiscal stimulus, along with hopes of a vaccine for the COVID-19 pandemic and early data points on recovery.
The four biggest central banks have expanded their balance sheets by almost 30% of GDP compared to 7% during the global financial crisis (GFC). The U.S.’s $3 trillion fiscal stimulus package is the largest in history and accounts for 15% of GDP. The U.K. Government announced a £330bn rescue package to save the economy. Germany abandoned its cautious approach to spending by announcing a €130bn fiscal stimulus package. What is different now versus the GFC is that this crisis is truly global and borne out of nature, and not due to leverage or irrational exuberance. That means there is probably no 'magic bullet' to solve this crisis and its length may depend on the arrival of a vaccine.
As of June 30, 2020, the Fund was overweight consumer staples and materials. MFS feels many of the consumer staples companies it owns have pricing power and derive a significant portion of their revenues from underpenetrated emerging market countries. Within materials, the overweight is in the chemicals industry. The Fund owns two industrial gas producers: Linde and Air Liquide. These high-quality cyclicals have generated returns above their cost of capital and significant free cash flow over a full cycle, driven in part by long-term contracts that have built-in price escalations. These companies may experience increased volumes for oxygen and respiratory apparatus in their health care related operations during the pandemic.
The Fund was most underweight consumer discretionary and communication services. In consumer discretionary, the underweight was focused on the internet and direct marketing retail sub-industry. The portfolio manager has consolidated its positions into Tencent, preferring the strategic positioning and longer runway for Cloud payments and advertising. The underweight to communication services is primarily the result of not owning any telecommunications companies that are facing increased regulatory constraints on returns and increased competition.
Significant trades during Q2 include:
- Added to existing positions in drug makers Novartis and Novo Nordisk. Novartis appeared attractively valued relative to European pharmaceutical peers, and Novo Nordisk has several drugs in late stage development that appear promising.
- Continued to build new positions in Tencent and Dassault Systèmes.
- Trimmed Taiwan Semiconductor, a large position that looked expensive relative to the overall market.
- Sold out of the Alibaba position, as a swap into Tencent.
- Sold out of the position in Intertek on concerns over valuation long-term growth prospects.
European shares have rebounded as economies across the continent begin the slow process of reopening. Significant monetary intervention from the European Central Bank (ECB) via its Pandemic Emergency Purchase Program, recently increased in scope to €1.35 trillion. Additionally, heavy emergency fiscal outlays across the continent and prospects for a potential first step toward fiscal union, have helped soothe investors' nerves.
Along with the rest of the developed world, U.K. policymakers acted aggressively to offset the economic damage caused by the COVID-19 pandemic using fiscal and monetary tools. As a result of the coronavirus lockdown, the economy is forecast to contract around 7.5% in 2020. Overhanging the U.K. economy is a lack of progress with the European Union toward a post-Brexit trading arrangement. The U.K. has refused to extend the transition period in order to negotiate a comprehensive agreement.
With relatively fewer monetary policy tools at the Bank of Japan's (BOJ) disposal, Japan has aggressively used fiscal policy in an attempt to offset the economic impacts of COVID-19, pledging government expenditures totaling the equivalent of US$2.2 trillion. The BOJ has pledged to maintain its ultra-low rate policy at least through fiscal year 2022, increased purchases of exchange-traded funds and instituted corporate support measures. Foreign demand for Japanese exports will be critical to their economic recovery. The collapse in global demand early in Q2 due to COVID-19 lockdowns will be a difficult hurdle in the near-term, however the hope is that the tremendous amounts of fiscal stimulus being distributed around the globe will be enough to revive demand worldwide, not just domestically.
Recent pandemic-related figures from parts of Asia, including China, South Korea and Vietnam, show that
COVID-19 outbreaks appear under control for now. However, new cases are on the rise in India, Latin America and parts of Africa. As nations with declines in new cases begin to reopen, recoveries are taking place in Asia and parts of Emerging Europe. Although there has been a recent rise in the services Purchasing Managers' Indices among the Brazilian, Russian, Indian, and Chinese (BRIC) economies, the team feels services are likely to lag manufacturing, as manufacturing companies may be less impacted by continued social distancing measures than their service-oriented counterparts.
Significant impacts on performance