Coffee Break 8/3/2020

LAST WEEK IN A NUTSHELL

  • The coronavirus pandemic resulted in a record contraction of the US economy by 32.9% QoQ (annualised).
  • The US Congress could not yet find common ground on a coronavirus relief to replace the expired federal unemployment benefits, pushing the country further towards a fiscal cliff.
  • The Federal Reserve held interest rates steady. In the same announcement, a tepid outlook on the coronavirus-plagued economy was brought up. The dollar weakened against the euro.
  • Sentiment-linked data showed improvement in the German IFO and broad euro zone but not in the US. The University of Michigan Consumer Sentiment Index dropped to 72.5 (vs. 73 expected).
  • The clock kept ticking on the UK’s transition period with the European Union. The talks between EU chief negotiator, Michel Barnier, and his counterpart, David Frost, remained in an impasse.

 

WHAT’S NEXT?

  • Global PMI data will be released and help assess whether the rebound in business activity from the Covid-19 lockdowns has been sustained into July. Growth could falter after the initial rebound.
  • Central bank meetings will take place in the UK, Australia, India, Russia and Thailand. The Bank of England is under particular scrutiny after recent wranglings over recovery prospects.
  • The US Bureau of Labor Statistics will release the monthly job report. Forecasts for the nonfarm payrolls predict little to no progress as the virus continues to spread.
  • The earnings season will continues with over 1,400 companies reporting. Less guidance than usual have been issued but results have positively surprised so far.

INVESTMENT CONVICTIONS

  • Core scenario
    • Our central scenario forecasts 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 is on the rise in the US because of the uncurbed coronavirus crisis and because of the current political context. Also the strength of the financial market and the cautiousness of investors are at odds.
    • The European policy response has given some reassurance: policymakers have successfully addressed several flaws in the past weeks which could result in a decline in euro zone equities’ risk premium. The past weeks could be seen as the fiscal equivalent to the monetary “Whatever it takes”.
    • Our main convictions are as follows:
      • First, stay with the medium-term “winners” of the crisis, such as Technology, Healthcare, Sustainable themes.
      • Second, add positions in assets at historically attractive valuation levels, as it provides investment opportunities. 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. In the US, new cases seem to be stabilising and there are less casualties. In Europe, a second wave is possible but countries would be better prepared if it would occur. In India, the rate is currently one of the strongest increasing trend.
    • 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 bottoming and steadily ongoing recovery of economic indicators, the rise in economic surprises and stabilising earnings revisions. Financial markets have integrated the improvement fast and might be ahead.
    • From a longer-term perspective, 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 more inclined 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 until a vaccine is found and commercialised. Local outbreaks are likely, a second wave is possible but a generalised worldwide shutdown is unlikely. Countries have gained in experience in handling a virus: testing, tracking and imposing safety measures.
    • US election risk. The handling of the coronavirus crisis, economic strains, social unrest and a potential fiscal stimulus cliff early August 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 stockmarket due to a possible tax reform and increased 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.
    • Trade negotiations between the UK and the EU. EU negotiator Michel Barnier expects the “moment of truth” for any potential trade deal in October. A “thin” free trade agreement is a realistic assumption.

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We remain overall underweight equities, and given the current context, we keep our protection on US and European equities for now. We maintain gold and JPY as portfolio hedges. Besides our deep convictions in the structural reduction of the euro zone risk premium and in an overweight EMU equity vs US equities, we also believe in the weakening of the USD vs the EUR. We have therefore recently increased our underweight USD vs EUR. We are neutral UK equities as the country has the potential to catch up with the rest of Europe based on better economic data, government fiscal support and a better control of the epidemic. 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 reponse 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 likely imminent fiscal cliff and electoral uncertainty, valuations are no longer attractive vs. historical levels. Also, buybacks, an important driver in the past 5 years, should be much lower.
    • 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 likely to suffer from declining profit forecasts.
    • 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.



coffee break