LAST WEEK IN A NUTSHELL
- Several European countries set new individual records as they counted thousands of new infections of COVID-19. Stringent measures were announced, putting economic growth at risk in the short term.
- US markets were off to a good start in Q3 earnings season, with improved credit quality and continued capital markets momentum helping banks to surprise positively.
- In the US, the labour market recovery could be running out of steam as highlighted by the highest jobless claims level registered in 7 weeks.
- The Philadelphia Fed’s manufacturing business survey rose to better-than-expected 32.3 points, the highest since February as the indicators for current activity, new orders and shipments all increased.
- Global flash PMI will be released, likely highlighting the pursuit of regional divergence among European countries and China keeping its lead over the rest of the world.
- Regarding Brexit, the important thing is that the UK is not ending talks at this point. Between COVID-19 and the exit from the EU, the UK outlook is exceptionally uncertain.
- The Q3 2020 earnings season will gather steam and commentary is more positive. The dominant factor remains the evolution of the virus, leading to light guidance for upcoming quarters.
- The final scheduled presidential debate is supposed to take place on Friday. The debate commission will aim for a more structured format.
- Core scenario
- Our central scenario forecasts the pursuit of a gradual but uneven recovery of financial markets, mainly thanks to abundant liquidity and government support. The momentum could stall towards year-end as we expect uncertainty to peak.
- In the US, due to the elections and the lack of a decision on a new fiscal stimulus package.
- In Europe, due to Brexit and the rising COVID-19 infections in many countries. France, Germany and England are renewing with social restrictions to curb a new coronavirus wave.
- 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). On the monetary side, the ECB signalled further stimulus.
- Our main convictions are as follows:
- First, we stay with the perceived “winners” of the crisis: the countries and the sectors that have shown the most resilience this year, e.g. Technology, Healthcare, Environmental themes, Germany vs the euro zone, China vs the rest of the world.
- 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 biases (Europe and Emerging Markets -especially Chinese A-shares- vs. US and Japan).
- Third, we expect a relief rally upon the announcement of an approved vaccine and are building a “re-opening” basket .
- Market views
- From a short-term perspective, less positive economic surprises are to be expected as expectations have been lifted up and mobility restrictions are likely to weigh on services. Real rates have stopped decreasing awaiting further central bank guidance or more clarity on the political and epidemic front.
- 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. The odds of a Blue Sweep have recently risen.
- Historically, economic recovery (and increasing rates) have been a support for value style performance. Until now, value has not performed as rates have remained low. With slower economic momentum and the Fed’s new monetary policy framework, there is no clear cut argument to favour one style over the other.
- From a longer-term perspective, accommodative fiscal and monetary policies and the prospect of a vaccine should lead to a recovery of the economy.
- The coronavirus pandemic is the main obstacle to the economic recovery. Only a vaccine could reverse the trend.
- 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.
- 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. The UK’s Brexit deadline is fast approaching and the country still lacks a deal with the European Union.
RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY
We remain overall slightly underweight equities, and given the current context of uncertainties, 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 adding to our overweight emerging markets equities and remain underweight Japanese equities. Finally, we take some profit on emerging market debt (hard currency) but still keep a reduced exposure to the asset class.
CROSS ASSET STRATEGY
- Our equity exposure is slightly underweight, but with an increased selectivity in regional equity allocation. Even more so now as the economic recovery is increasingly uneven between countries. A robust governance appears to deliver better results during the pandemic, both at company and state level.
- We are overweight euro zone vs. underweight US equities and with a preference for the German equity market. The coordinated response of member states to the virus has strengthened ties. Recovery is uneven between member states though and Germany stands out in terms of governance and performance. 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 in North America.
- 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 expect a “light” Brexit agreement, perhaps after more drama along the way.
- We increased our overweight emerging markets equities vs. underweight Japanese equities and have a preference for the Chinese equity market. China stands in a V-shaped economic recovery and is leading the rest of the world by several months.
- 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 and environmental themes enable exposure to key solutions for a cleaner future and will continue to gain in importance.
- 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 investment grade as central banks’ buying represent a support.
- While we stay overweight Emerging market debt, we have taken some profit on our exposure in hard currency. Bond markets have largely recovered from crisis levels seen earlier this year.
- 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.