Last week in a nutshell
- Many major central banks were gathering last week and announced some hawkish news, igniting significant upward revisions in bond yields.
- In the US, the Fed left its monetary policy unchanged but projected to start bond-buying taper soon and to end it in mid-2022.
- In the UK, the BoE comments were unmistakably hawkish with the MPC fuelling market expectations that it will likely raise rates in early-2022.
- In Japan, the BoJ kept its policy steady, as expected before elections. South Africa and Switzerland kept their monetary policy also unchanged.
- Norges Bank in Norway was the first in the G10 to raise rates by 25bps, projecting another increase before year-end, leading to a stronger NOK.
- In Brazil, the BCB decided the fifth consecutive hike in the SELIC rate and raised the policy rate by 100 basis points to 6.25%, in line with expectations.
- Turkey surprised by a cut in its key rate by 100 basis points to 18% leading to a new depreciation of the Turkish lira, hitting a historical low.
- The situation of Chinese property developer Evergrande moved markets as the company failed to make an interest payment on loans due last week.
- China began acquiring liquid natural gas for the winter, which may exacerbate the global supply shortage. In the past two months alone, the price of natural gas has risen by + 50% in Europe.
- Flash PMI surprised on the downside, in particular in Europe, reflecting a cooling of sentiment and activity amid worsening supply constraints and growing price pressures.
What’s next?
- The result of the general elections in Germany imply an absence of extreme policy changes but it will take time to know the new government. The current Merkel-led government will be handling the necessary matters as a caretaker until a new coalition is sworn in.
- In the US, it’s the government funding deadline this week, and we could also see some action on the bipartisan infrastructure bill. Republican opposition in the Senate might block the bill passed in the House.
- In Japan, the leading LDP party will designate its new leader. There are four candidates to succeed PM Suga: Fumio Kishida, Taro Kono, Sanae Takaichi and Seiko Noda
- China will enter the Golden Week which is usually a period of heightened travel activity.
Investment convictions
Core scenario
- In our central scenario we consider that growth is impacted by temporary factors and we maintain the view that we are in the middle of the reopening, not of the economic recovery cycle. Reflation plays have a more attractive risk-reward and should benefit from the reduction of risks perception. The expected gradual rise in real rates is the key trigger for a possible outperformance of the value part of the market.
- We believe that this context remains positive for ex-US equities, value stocks and assets (banks) and should lead to higher yields.
- In the US, growth and inflation data should stay at elevated levels and the Fed is expected to announce a tapering by the end of the year.
- In Europe, monetary dynamics are still positive and should stay accommodative. Fiscal dynamic should remain positive with the roll out of the NGEU and the upcoming election in Germany which could help the EU risk premium decline.
- 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
- Industrial activity is levelling off, mostly constrained by supply chains bottlenecks.
- Latest macroeconomic data publications were more mixed and Q3 was globally weaker than expected, in particularly in China and in the US.
- 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 American equities and China A onshore stocks.
- Simultaneously, our core portfolio keeps the most resilient themes and countries.
Risks
- The delta variant is spreading particularly threatening countries and regions that are less well vaccinated. This did not stop the reopening of the economies in developed countries. With fall arriving, this reopening should go better than last year.
- Fed and ECB tapering will be another focus in the coming weeks. Inflation is still widely seen as temporary, which should allow central banks to control their communication and avoid any policy mistake.
- Regulatory tightening in China has triggered a correction in July / August on Chinese stocks and on stocks exposed to China. Policy easing should help find some support and allow some catch up in Q4.
Recent actions in the asset allocation strategy
Chinese property developer Evergrande was in focus. The firm‘s total liability size is over $300bn, accounting for 6.5% of the total liability of the Chinese property sector. It is also the largest high-yield USD bond issuer, accounting for 9% of the total offshore bond market and 12% of the total High Yield offshore bond market. Evergrande has allegedly borrowed money from over 120 banks and over 120 non-bank institutions.
ECB President Christine Lagarde said direct exposure to Evergrande in Europe, and the euro zone in particular, is “limited”. She added, “for the moment, what we are seeing is China-centric impact and exposure.” This echoes Fed chair Jerome Powell’s remarks that there is little direct US exposure to the company’s debt, but that the situation could impact global financial conditions. Although the debt is sizable, it should still be manageable eventually. Nevertheless, it will be an arduous process for Evergrande to dispose of its assets at market levels and restructure the debts to meet its liabilities and reduce the damage as much as possible. But we think the Evergrande event is unlikely to lead to banking system collapse in China.
In this context, we keep our preference for China A (onshore) shares as we believe policy easing should help find some support and allow some catch up. The government has lastly used ammunition to support the current transitional phase by easing the RRR. We believe this trend could continue through a rebound of the Credit impulse but also through a rebound of local government issuance during H2 2021, which would support Chinese onshore equities.
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 a currency exposure to the NOK. - Positive stance on Small caps
Current context is supportive for ongoing rotation towards stocks geared to the recovery and a steepening of the yield curve. We have a position on small and mid-caps in the US and Latin America. - Positive stance on Global Banks
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 1.75% by the end of this year. - 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. Tech and Innovation themes, as well as Oncology and Biotech sectors reveal high growth potential.
