Last week in a nutshell
- The Bank of England meeting left interest rates and QE unchanged in a context of growing inflation - peaking at 4% - but still considered to be transitory.
- In terms of data, the US economy added 943k jobs in July, the most in eleven months and above market expectations, with jobless rate falling to 5.4%. Continuing claims fell to their lowest levels since March 2020, falling below 3 million.
- In China, the official NBS Manufacturing PMI slowed to 50.4 while the service PMI was firmer, easing slightly to 53.3. However, the Caixin Services PMI for July surprised on the upside (54.9) and might help ease growing worries over the delta spread.
- Brazil increased its key interest rate by a percentage point to 5.25% in an effort to curb runaway inflation, which is running at over 8% YoY.
What’s next?
- The US will release CPI data after Treasury Secretary Janet Yellen said that inflation should be elevated “for some time,” before reaching by the end of the year “a pace consistent with the Fed’s interpretation of price stability”.
- Investors will closely follow potentials signals from ECB on PEPP’s future as sources report that an extension beyond March 2022 and another addition of €500bn will be considered.
- In order to open up to the outside world, the White House might put forward a plan that all foreigners arriving in the US have to be vaccinated.
- China will, once again, be in the spotlight as the Politburo meeting signalled the likely end of macro policy tightening by dropping the phrase "no sharp policy turn" due to pandemic uncertainty and uneven domestic recovery.
Investment convictions
Core scenario
- The economic recovery should continue in 2022 with continued fiscal support and prudent central banks. Developed countries have peaked on the pace of vaccination, economic indicators, liquidity, fiscal support and are entering the transition phase to still strong but more differentiated economic growth.
- The risk reward seems less attractive for the next few weeks until a clearer and more positive direction is found. The delta variant may pose a risk to growth.
- We believe that this context remains positive for ex-US equities, value stocks and assets (banks, commodities) to hedge inflation and higher yields.
- In the US, more spending and more taxes are expected. The former could support higher yields, while a coming tapering should be announced in the coming months.
- In Europe, our central scenario assumes a comeback to growth trend by end-2021 and an implementation of the Next Generation EU plan in H2. Economic indicators still reveal a gap to be filled between services and manufacturing, with the latter starting to incorporate the global economic rebound. However, current valuation looks expensive especially for small caps vs large caps.
- In emerging markets, we assume that Latin America should further benefit from the catch up in the reopening trade. On the long run, China should benefit from growing domestic demand.
Market views
- Central bank communications and the pace of nominal rate increases will determine the performance and volatility of the financial markets in the next phase.
- Markets have well integrated the stage of the strong “mechanical” rebound after the pandemic, as evidenced by the strong outperformance of cyclicals. We may now expect positive but lower returns.
- Investors’ sentiment and positioning have recovered from crisis levels and recent Fed-induced volatility but are not yet complacent or extreme.
- We are sticking to our positioning that favours non-US equities and we keep hedges against higher yields and inflation. We are buying European and US banks, US small and mid-caps, and have an exposure to Emerging countries with a bias through Latin America equities and China A onshore stocks.
- Simultaneously, our core portfolio keeps the most resilient themes and countries.
Risks
- The virus vs vaccine duel. A resurgence of infections due to the delta variant underlines the risk of economic restrictions lasting longer than initially expected. The mutating coronavirus should become endemic, as immunity is not steady and therefore needs a constant and full commitment to the vaccination campaign.
- Uncontrolled rise in bond yields. Some US indicators are already pointing to a stronger labour market. Should this materialise in the upcoming employment reports, we may see higher yields, both real and nominal.
- Supply-side constraints. Corporates have warned about the difficulties they are having hiring and also building their inventories to meet the rebound in demand. If this takes too long, such a context could bring more price rises without higher growth, putting margins under pressure.
- Geopolitical tensions. Tensions between China, and/or Russia, and the US are on the agenda, as witnessed by the G7 and NATO summits.
- Political uncertainty. The social divide is widening between losers and winners of the health crisis and several countries have elections coming up in the next 12 months starting with Germany which will elect a new Parliament in September.
- Regulation uncertainty in China. The current regulation tightening occurring in China needs to be monitored. While currently limited to overseas IPO and the Education sector, any spill over through tighter rules or to other sectors could have an impact on Chinese and Emerging equities.
Recent actions in the asset allocation strategy
After a first quarter buoyed by hopes of an end to the health crisis and strong equity performance, we can now expect positives returns, but at a lower level, with much higher sensitivity to bond yields’ evolution and stretcher valuations of risky assets. We also expect a more sideways phase and a possible increase in volatility before finding a clearer direction and a continuation of the reflationary environment. In this context, we decide to remain neutral equities, with a preference for ex-US equities and value stocks.
The Chinese market has recently raised concerns as the educational sector was hit by a new regulatory framework. As this new Chinese paradigm might very well maintain a decent level of competition, leave room for smaller tech companies to emerge, and support local investments benefiting to onshore stocks, we decided to maintain our exposure to domestic Chinese equities, while remaining more cautious on offshore companies.
We are keeping hedges against higher yields and inflation and some derivative protections. We have identified various possible catalysts for an equity market correction from which we might take advantage of.
Cross asset strategy
We expect a more sideways phase with a possible increase in volatility before finding a clearer direction and a continuation of the reflationary environment. We are neutral equities and underweight bonds.
On the equity side, the impact of the pandemic is set to diminish and, as countries emerge from the crisis, their economies should rebound and rebuild. The COVID crisis may have little effect on the long-term growth potential of economies and is even pushing for accelerated productivity gains. Rebuilding after the pandemic implies that growth will perhaps be different, with less globalisation and more green and equitable growth, but it could also mean margin pressure for some companies. Hence our strategy is geared towards reflation trades and long-term winning sectors. Our multi-asset investments can be summarized as follows:
- We have exposure to assets related to the post-COVID rebound/recovery
Neutral equities, underweight bonds, preference for ex-US equities especially Emerging Markets through Latin America equities and China A onshore stocks.
Underweight government bonds, keeping a short duration. We focus on the source of the highest carry, i.e. emerging debt. We stay neutral US and European investment grade credit.
We have an exposure to rising commodity prices, via a currency exposure through the NOK. - Positive stance on Small caps
Current context is still supportive for ongoing rotation towards stocks geared to the recovery, a steepening of the yield curve and rising commodity prices.
We have a position on small and mid-caps in the US and Latin America, and decided to take profit on our UK exposure. - Positive stance on Global Banks
In spite of a sharp rebound in the past months, Banks in the euro zone still present a steep discount to their long term average and we are adding EMU banks. We also keep an overweight stance on US banks, which could benefit from the yield curve steepening. We expect US 10Y yields to hit 2% in the next 12 months. - Positive stance on long term growth thematics
Inclusion of secular megatrends to profit from long-term sustainable growth. The pandemic revealed that they are helpful in building a resilient portfolio. Environmental solutions, digitization and healthcare are our strongest thematic convictions.
Oncology and Biotech sectors reveal high growth potential.
Keep exposure to Tech and Innovation themes.
Purchase of consumer staples in the European Food & Beverage sector.
