Over the last couple of months, Candriam has been embracing the global economic recovery by putting more emphasis on small- and midcap companies and on value sectors, such as banks, and positioning for a steepening of the yield curve. Our scenario of a global economic rebound, followed by a genuine recovery, is taking shape and recent market moves have put the focus on our investment convictions. In our view, financial markets this Spring are likely to be influenced by the next steps in the fight against the pandemic.
In 2020, being nimble and managing the portfolio actively meant navigating between significant risk-on and risk-off phases in the market. In the first months of 2021, however, markets have been driven predominantly by internal factors rather than investor appetite (or the lack of it). Therefore, there have been an increased investor focus on different investment themes. Clearly, our portfolios include an exposure to secular megatrends in order to benefit from long-term, sustainable growth. The pandemic revealed that they are helpful in building a resilient portfolio – environmental solutions, digitalisation and healthcare remain our strongest long-term thematic investment themes.
Another important part of our asset allocation is currently geared towards the so-called reflation, the effect of central bank policies aimed to stimulate a simultaneous rise in economic output growth (the REcovery) and in prices (the inFLATION) after period of economic uncertainty or a recession. We note that, at the start of previous economic recoveries, bond yields tended to increase, whereas risk aversion decreased. At the same time, we are seeing growing concerns about inflation, central bank tightening and public debt issuance. Our first chart shows both legs of the “reflation”: the recovery in manufacturing orders and the rise in bond yields, which can be seen as a mirror of higher inflationary pressures.
Chart 1: US ISM Manufacturing New Orders VS. 10y yields
So far, the rapid pace in the ongoing reflation can be explained by fundamentals. After November 2020, when BioNTech and Pfizer announced the good news about the efficacy of their COVID-19 vaccine, the flow of positive news continued. In December 2020, the Trump administration engineered a USD900 billion stimulus, followed by a unified Congress in January, implying further new stimulus. In February 2021, it emerged that the COVID-19 relief package proposed by the Biden administration would actually be at the higher end of the proposed USD1.9 trillion. This has led to most economic scenarios and corporate profit targets being revised upwards. And so were bond yield expectations.
So, what are the next steps investors can expect to see in the fight against the pandemic? Cassandras might point to an end of the series of incremental positive surprises. But a closer look at the economic indicators reveals that there is still a large gap to be filled between services and manufacturing, as the latter has already started to benefit from the economic rebound. The chart shows that we are witnessing today the most significant spread of the past quarter of a century between those two parts of the economy in the euro area (with the exception of the most acute lockdown phase in March and April last year).
Hence, the reflation trade could well move into the next phase as the economy reopens. The accumulated consumer savings will likely support a COVID-19 sensitive spending rebound, igniting hereby a feedback loop in the economic recovery. The impact of the re-opening road map announcements made by the British Prime Minister Boris Johnson on 22 February on the market value of EasyJet, Ryanair, TUI or Jet2 are a case in point illustrating pent-up demand for travel and leisure.
If total spending on goods and services after the lockdown period rises beyond levels registered after the Global Financial Crisis, we would expect the reflation theme to intensify. On the short end of the yield curve, an important marker to follow will be if the median of the FOMC (Federal Open Market Committee, which determines the course of the US monetary policy) dots data projection for the longer term (i.e. post-2023) Fed Funds target rate and its revision upwards from its current level (2.50%). As the services areas of the global economy revive, we cannot exclude another upward move in longer-term bond yields. In this case, the value / re-opening / cyclical investment themes are likely to outperform growth / stay-at-home / defensive themes.
Chart 2: Euro area Services PMI VS. Manufacturing PMI
