LAST WEEK IN A NUTSHELL
- September flash PMIs hinted at a weakening in momentum in services, most vulnerable to the resurgence in coronavirus infections, whereas manufacturing fared much better.
- In his testimony before Congress, Fed chair Jerome Powell, pledged that the Fed’s would support the economy “for as long as it takes”. Even with some improvement since Q2, the path ahead remains “highly uncertain”.
- The death of liberal US Supreme Court Justice Ruth Bader Ginsburg has triggered a controversy. Replacing her before the Presidential election would give President Trump the chance to cement a 6-3 conservative majority on the court.
- Andrew Bailey, Governor of the Bank of England, highlighted the mixed results of using negative interest rates. Although their use remains possible, it is not yet on the agenda.
- Politics will move into the spotlight at the start of Q4 as there will be the first presidential debate in the US as well as the resumption of Brexit negotiations between the UK and the EU.
- House Democrats are putting together a $2.4tn coronavirus stimulus plan. The vote on the legislation could come as soon as this week, but political polarisation in Washington makes a compromise unlikely.
- In terms of data, the US will release its last monthly job report ahead of the elections. Further, we expect inflation-related data and final Q2 GDP growth rates for the US and UK.
- Soft data is also on its way on both sides of the Atlantic with series on consumer confidence sentiment, current conditions and inflation expectations.
- Core scenario
- Our central scenario forecasts the pursuit of a gradual recovery of financial markets, mainly thanks to abundant liquidity and government support but the momentum could stall towards year-end. Markets should continue to trade in a wide and choppy range. Uncertainty remains in the US because of the current political context, exacerbated by the upcoming nomination of Justice Ruth Bader Ginsburg’s replacement and the high number of coronavirus infections. A new US fiscal stimulus package could reignite momentum if Congress can agree on a new plan.
- 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
- Historically, economic recovery (and increasing rates) have been a support for value style performance. This time, value has not performed as rates have remained low. With slower economic momentum and Fed new monetary policy, there is no clear cut argument to favour one style over the other.
- 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. A congressional deadlock is possible.
- From a short-term perspective, less positive economic surprises are to be expected as expectations have been lifted up. Real rates have stopped decreasing awaiting further central bank guidance.
- 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. 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 the region is under-owned. Further rapid euro appreciation could be a risk to future 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.
- 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 stands in a V-shaped economic recovery and is leading the rest of the world by at least 2 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 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. The asset class continues to offer carry.
- 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.