Markets remain in a singular situation, caught between the possibility of a vaccine by the beginning of next year and the fear of a second epidemic wave in the autumn. If economic data releases remain resilient, the still-applicable mobility restrictions are disquieting investors. Hopefully, the abundant liquidity and a weaker US Dollar will help sentiment. Let’s see where we stand and how we define our cross-asset strategy, taking these elements into account.
Economic data resilient
In this singular situation, economic data remain sound, notably in the US. But Europe is catching up, as economic surprises accelerate. Around the world, PMI remain notably well oriented. In Europe, the ZEW index level is benefiting from the same economic confidence. Likewise, China, too, which surprised by its lower-than-anticipated growth slowing, could recover its pre-Covid level by the end of the year.
Central banks, moreover, remain very supportive and governments are still fiscally active. In the US, in this election year, fiscal support is more difficult to find but should be acted in the end.
The Q2 earnings season was less severe than feared, as was the guidance, even if less detailed than usual. Notably, tech company earnings surprised positively. For the time being, earnings estimates reveal better resilience than during the 2008 GFC shock.
Epidemics remain robust on a global scale but hope springs eternal.
The number of cases is dropping in the US, as are hospitalizations. The younger generation is now the most affected but seems to be more immune. In Europe, some countries are again registering a rise in the number of reported infections. Three reasons may explain this situation: the growing number of tests, the tourist flows of the summer months, and the drop in vigilance (notably among the young). But, due to this demographic shift towards the younger population, the number of deaths remains low compared to the spring. Some mobility restrictions have been reintroduced.
The situation in the Southern Hemisphere, in Australia, for example, must be monitored, too, to assess the impact of winter on the epidemic. Some emerging countries, such as India, Brazil and Peru, remain very affected.
Which factors could move the markets and our positioning?
The epidemic remains the principal source of investor preoccupations. The economic consequences of the different scenarios are being scrutinized. A second wave in autumn or winter would make it more difficult for the corporate sector to withstand the situation. More local lockdowns could affect consumption and companies’ willingness to invest and to increase their capital expenditures. Conversely, the discovery of a vaccine earlier than anticipated would be very supportive and increase optimism among decision-makers.
The US elections may influence the markets more in the near future. If history is any guide, investors only really start to pay attention about 70 days before the election date. The polls are currently in favour of Joe Biden but the true question concerns the control of Congress. The odds have become more balanced recently, and the possibility of a blue (Democrat) wave and a tax hike have receded slightly. It remains to be seen if the nomination of Kamala Harris as running mate will move the polls.
Sentiment is not excessively optimistic and cash is only starting to exit money market funds. In that regard, risky assets should continue to be pulled by this liquidity boom and the progressively improving investor sentiment, which should also continue to favour lagging stocks and sectors (value) and cyclicals in the current economic rebound as well as credit investment grade and emerging bonds.
Some assets, such as gold and silver, show that investors are worried about a currency debasement. We think this fear will stay as central banks remain very supportive, continuing to provide an abundant supply of liquidity. Inflation risks remain limited for this year and next but need to be monitored over the longer term, and justify for the time being a cautious approach to government bonds.
Our current multi-asset strategy
Our overall equity exposure has stayed slightly cautious, due to the obvious risks, and we are continuing to protect European and US equities via options and portfolio hedges (gold and JPY).
To benefit from the ongoing economic recovery, we are keeping our exposure to a structural reduction of the euro zone risk premium: long EMU vs US equities. We also remain neutral UK equities, as, even though these could benefit from better control of the epidemic, the Brexit situation may weigh on them.
We are keeping Chinese A-Share equities and remain overweight on emerging equities but underweight Japan.
We have not changed our bond allocation and remain positive on credit Investment Grade (Europe and US) and emerging debt.
We are also maintaining a short duration bias and an underweight exposure to government bonds in Europe (on core countries).
Our currency allocation is negative on the USD vs. EUR and long on NOK vs. EUR.
