Coffee Break 8/31/2020

INVESTMENT CONVICTIONS

• Core scenario
  • Our central scenario forecasts the pursuit of a gradual recovery of financial markets, mainly thanks to abundant liquidity and government support. In the coming months, markets should nevertheless continue to trade in a wide and choppy range. Uncertainty remains in the US because of the current political context and the high number of coronavirus infections. The generous enhanced unemployment benefits ended late July and the next step is increasingly uncertain. So far, Congress has failed to agree on a new stimulus package.
  • The European policy response has given some reassurance by agreeing on the recovery plan for Europe: a combination of the long-term EU budget and Next Generation EU – a total of 1.8 trillion EUR. It ought to result in a decline in euro zone equities’ risk premium. However, for now, European equities are somewhat weighed down by a strengthening EUR and, in the absence of a vaccine, a rotation towards cyclical and value sectors stays at bay.
  • Our main convictions are as follows:
    • First, we stay with the medium-term “winners” of the crisis, such as Technology, Healthcare, Environmental themes.
    • Second, we added positions in assets when they were trading at historically attractive valuation levels. We have identified Banks among value sectors, Emerging market debt and cheap currencies. We have also increased some regional accents (Europe and Emerging Markets -especially Chinese A-shares- vs. US and Japan).

• Market views
  • Volatility is here to stay as visibility on the epidemic and its aftermath remains low.
  • The spreading of the virus remains the main threat as it could not be curbed everywhere and/or the threat of a second wave is increasing depending on the region.
  • Fiscal and monetary policy responses will outlive the virus. Monetary policy responses aim at ensuring ample liquidity and, for some regions, further asset purchases programmes. For now, their actions seem to provide a safety floor to financial markets.
  • From a short-term perspective, some reassurance can be found in the ongoing recovery of economic indicators, the rise, albeit slightly less dynamic lately, in economic surprises and stabilising earnings revisions. Financial markets have integrated the improvement fast and might be ahead of the curve.
  • From a longer-term perspective, besides a vaccine, H2 earnings will be key and determine the shape of the recovery. A V-shaped recovery seems to be the most likely one with a flatter second leg. The market does not seem to take into account the possibility of a second crisis or even stagnation.

• Risks
  • The coronavirus pandemic is the main threat to the economic recovery. Only a vaccine could reverse the trend. Several companies are in the final stages of testing.
  • US election risk. The handling of the coronavirus crisis, economic strains, social unrest and a potential fiscal stimulus cliff are triggering uncertainty at a time when valuation is no longer appealing vs. historical levels. A Democratic sweep on election day could represent a risk for the stock market due to a possible tax reform and increasing regulation.
  • The US-China relations will likely remain on edge and are clouding global growth. Neither country can afford a revival of a trade war. After a tit-for-tat battle that saw the closing of consulates in both US and Chinese cities, the Trump administration is now issuing recommendations that Chinese companies listed on US stock exchanges be delisted unless they provide US regulators with access to their audited accounts.
  • Trade negotiations between the UK and the EU. UK’s chief negotiator, David Frost, tweeted that “agreement can be reached in September” while EU’s Michel Barnier warned that a Brexit deal is “unlikely” as progress stalled.

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We remain overall underweight equities, and given the current context, we keep our protections on US and European equities. We maintain gold and JPY as a portfolio hedge. Besides our conviction in the structural reduction of the euro zone risk premium and in an overweight EMU equities vs US equities, we also believe in a weaker USD vs the EUR. We are neutral UK equities as the country has the potential to catch up with the rest of Europe. We are overweight emerging markets equities (via Chinese A shares) vs. underweight Japanese equities. Finally, we keep an exposure to emerging debt and investment grade bonds.

CROSS ASSET STRATEGY

• Our equity exposure is slightly underweight, but with an increased selectivity in regional equity allocation.
  • We are overweight euro zone vs. underweight US equities. The coordinated response of member states to the virus has strengthened ties while valuation still offers a relative discount vs the US and positioning is just starting to pick-up. Usually, a recession-resilient country, the US now appear more fragmented than Europe. Besides the imminent fiscal stimulus cliff and electoral uncertainty, valuations are no longer attractive vs. historical levels. Also, buybacks, an important driver in the past 5 years, should be less supportive in 2020.
  • We are opportunistically neutral UK equities. There is potential in a short-term catch-up by UK equities. The strong underperformance in the rebound shows a disconnection between the index and the state of the economy.
  • We are overweight emerging markets equities (via Chinese A shares) vs. underweight Japanese equities. China is rapidly recovering from the coronavirus crisis while Japan is entering an uncertain period following Shinzo Abe’s succession.
  • We keep key convictions in various thematic investments. Technology, Oncology and Biotech sectors prove relatively resilient in the current context and reveal high growth potential driven by innovation and pricing power. Climate action and circular economy themes enable exposure to key solutions for a cleaner future. We believe that sustainability will continue to gain in importance for the social and environmental aspects. A robust governance appears to deliver better results during the pandemic, both at company and state level.
• We are underweight bonds, keeping a short duration, but highly diversified as the current environment has the potential to create opportunities on bond markets.
  • We are underweight government bonds which provide no return potential except in risk-off phases. We prefer peripheral bonds vs. core European countries.
  • In a multi-asset portfolio, diversification into credit appears attractive. We are overweight US and EUR investment grade as central banks’ buying represent a support.
  • We are also overweight Emerging debt, including corporate bonds, with a preference for hard currency and ESG.
  • We have an exposure to the NOK, which appeared attractive during the crisis, as well as gold and the JPY, which are risk mitigators.
  • Our deep conviction in the structural reduction of the euro zone risk premium leads us to underweight the USD vs EUR.