Coffee Break 21/09/2020

LAST WEEK IN A NUTSHELL

  • Acknowledging the risks to the recovery, the Fed sent an unambiguously dovish message: rates at zero until at least end-2023 and a full labour market recovery and inflation hitting 2% and moving upwards.
  • The Bank of England met and is expected to overcome its previous reluctance to use the option of negative bank rates if the economy keeps deteriorating into 2021.
  • ZEW investor sentiment in Germany rose unexpectedly sharply. There is confidence in the recovery from the coronavirus in spite of the pandemic and political headwinds.
  • The ruling Liberal Democratic Party of Japan elected - by a large margin - Yoshihide Suga as Leader. Taking over mid-term, the new prime minister is expected to stay until the next general elections, scheduled for September next year.

 

WHAT’S NEXT?

  • September flash PMIs will give first insights into how the US, euro zone, Japan, UK and Australia, will end Q3. While August had shown a strengthening of the rebound, the recovery might be losing momentum.
  • Fed chair Jerome Powell will testify before Congress. Under scrutiny are the response to the pandemic, the expectations on the job market healing and the new strategic framework.
  • EU leaders will gather for a special European Council summit. The agenda includes a discussion on the single market, industrial policy and digital transformation, along with the EU’s external relations.
  • Investors will also keep an eye on Italy’s constitutional referendum and regional elections.

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 still uncertain. A new US fiscal stimulus package would reignite momentum but 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.
    • 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
    • Momentum or rotation from growth to value is the key question as the gap is widening between the two but is showing signs of early resistance. Key determinants will be the evolution of the economic momentum, the Covid-19 this autumn, US elections, and implementation of the new Fed strategy and its impact on interest rates and exchange rates.
    • Hence, volatility is here to stay because visibility on the epidemic and its aftermath remains low and because it is par for the course during presidential elections. The 2020 elections promise to be polarized.
    • From a short-term perspective, some reassurance can be found in the ongoing recovery of economic indicators, in positive 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 somewhat diminishing momentum. The market does not seem to take into account the possibility of a second generalized lockdown or even stagnation.
  • Risks
    • The coronavirus pandemic is the main obstacle 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. Once the election dust settles, there is a macroeconomic alignment on expansionary policy: higher spending (Biden) vs. lower taxes (Trump) in a context of an accommodative Fed but post-election congressional deadlock is still a risk.
    • 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. The UK’s Brexit deadline is fast approaching and the country still lacks a deal with the European Union, leaving the country at risk of a ‘hard Brexit’, i.e. the UK would follow World Trade Organisation (WTO) rules from 1st January 2021.

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We remain overall slightly underweight equities, and given the current context, we keep our protections on US and European equities. We maintain JPY and gold as a portfolio hedge. Besides our conviction in the structural reduction of the euro zone risk premium and in an overweight EMU vs US equities, we also believe in a weaker USD vs the EUR over time. We are neutral UK equities. 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. Valuations are no longer attractive vs. historical levels. Also, buybacks, an important driver in the past 5 years, appear less supportive in 2020.
    • We are opportunistically neutral UK equities. The UK has missed out on the global market rebound and a weak GBP should act as a support. It should come as no surprise that Brexit is a headwind for the UK but also for the broad European region.
    • 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. We believe that Climate action and environmental themes enable exposure to key solutions for a cleaner future and will continue to gain in importance. 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 be short USD vs EUR.



coffee break