Coffee Break 7/13/2020

LAST WEEK IN A NUTSHELL

  • The coronavirus pandemic continues, especially in the US and in Brazil, which still report increasing active cases and casualties, followed by India and Russia.
  • “Together for Europe’s recovery” is Chancellor Merkel’s motto as Germany takes over the EU presidency. The strategy and goals for the next 6 months were discussed in the EU Parliament.
  • The euro zone retail sales beat forecasts with 17.8% in month-to-month and recovering from a previous -12.1%. In the US, Markit Composite was at 47.9, revised higher after a first estimate of 46.8.
  • Brexit negotiations are muddling through as sticky points in trade talks persist from the level playing field to fishing quotas. The UK has also decided not to join the EU’s coronavirus vaccine programme.

 

WHAT’S NEXT?

  • The ECB will meet and shed some light on the future path of monetary policy. While the data point to a relatively sharp rebound, the region is still on course for its biggest contraction ever (almost 9%).
  • The European Council will also meet in person with a heavy agenda for the month of July. The EU has so far shown coordination and a will towards solidarity.
  • First Q2 GDP growth rate estimates for China will be released: Markets expect positive numbers as China has managed to overcome the Covid-19 outbreak and activity is recovering quickly.
  • Inflation-linked data as well as US retails sales are due. Consumption will be a driving force in the recovery, but is linked to social distancing measures.

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 range. From a short-term perspective, some reassurance can be found in the bottoming of economic indicators and the rise in economic surprises. Volatility is nevertheless here to stay as visibility on the epidemic and its aftermath remains low, in particular in the US.
    • Two messages stand out via the recent market performance: First, stay with the medium-term “winners” of the crisis (e.g. Technology, Healthcare, Sustainable themes) and, second, enter positions in assets at historically attractive valuation levels, also providing investment opportunities (we have identified Emerging market debt, value sectors, cheap currencies and euro zone equities relative to US ones).
    • Various epidemic indicators reveal that in Europe, the rate of contagion is falling in spite of easing lockdown measures. In the US and South America, new cases are going up, leading high-frequency mobility indicators to pause.
  • Market views
    • Most countries have reached their peak in terms of active Covid-19 cases, except for the Americas. The epicentre is now on both parts of the American continent.
    • 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.
    • The European political response has given some reassurance: policymakers have addressed several flaws in the past weeks successfully 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”. The July EU council could become an important milestone.
  • Risks
    • The coronavirus is a risk until it is contained or a vaccine is found, successfully tested, mass-produced and commercialised. Local outbreaks are likely, a second wave is possible but a worldwide generalised shutdown is unlikely.
    • US election risk. The handling of the coronavirus crisis, economic strains, social unrest and a potential fiscal stimulus cliff at the end of July 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 (tax reform and 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, we keep some protection on equities via options and maintain gold and yen as portfolio hedges. That being said, we have deep convictions in the structural reduction of the euro zone risk premium. It translates into an overweight EMU equity vs US equities. We also add some UK equities, thereby becoming neutral. The region has lagged the rebound and should benefit from better economic data, government fiscal support and a better control of the epidemic. We add Chinese A-Shares equities and thereby become overweight emerging markets while downgrading Japan to underweight. Finally, we take some profit on emerging debt in local currency and now have a preference for hard currency (ESG) instead. Overall exposure stays the same.

 

CROSS ASSET STRATEGY

  • Our equity exposure is slightly underweight, while increasing further the relative exposure towards the euro zone.
    • We have a stronger overweight euro zone vs. a stronger 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 remains low. Usually a recession-resilient country, the US now appear more fragmented than Europe. Besides the 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 have become neutral UK equities. There is potential in a short-term catch-up by UK equities after a disappointing month of June. The strong underperformance in the rebound shows a disconnect between the index and the state of the economy.
    • We add Chinese A-Shares equities and become overweight emerging markets while downgrading Japan to underweight. China is rapidly recovering from the coronavirus crisis while Japan is likely to suffer from a fall in profits.
    • 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 and their accompanying flight to quality. 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, taking some profit on the local currency debt exposure and having a preference for hard currency (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