Last week in a nutshell
- In the euro area, the ECB changed its inflation target to 2% and decided to leave extra room to keep rates low in the first review of its strategy since 2003.
- The minutes of the June FOMC confirmed discussions on an earlier reduction of asset purchases. There was still broad agreement that the increase in inflation was “largely reflecting transitory factors”
- In China, the PBoC announced a 0.5 percentage point cut in its reserve requirement ratio, effective from July 15, in a move that aims to offer more support to small and medium-sized firms.
- OPEC+ cancelled further talks on whether to increase production from August. Negotiations collapsed in a context of declining US inventories and rising demand for oil products.
What’s next?
- Surging delta coronavirus variant cases globally will increasingly become a source of worry as they could slow down the economic reopening as early as this summer.
- In the US, CPI data will provide more information as to whether yields this low are sustainable after the US 10-year yield dropped below 1.30% during the week.
- On the central-bank side, investors will pay attention to Fed Chair Powell’s semi-annual Monetary Policy Report to Congress, as well as the Bank of Japan’s latest monetary policy decision.
- The Q2 earnings season will begin to get going, with a number of US financials reporting, among others. Highlights include JPMorgan Chase, Bank of America, Wells Fargo, Citigroup and Blackrock.
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.
- Therefore, the risk reward seems less attractive for the next few weeks until a clearer and more positive direction is found. The delta variant and the upward pressure of oil prices may pose a risk to growth.
- Our exposures are tilted towards ex-US equities and assets to hedge inflation and rising yields (e.g. banks, commodities) and longer-term growth themes (e.g. innovation, environmental solutions and healthcare).
- 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.
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 and bouts of volatility.
- 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 commodities, GBP and NOK.
- Simultaneously, our core portfolio keeps the most resilient themes and countries.
Risks
- 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.
- 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.
- Geopolitical tensions. Tensions between China, and/or Russia, and the US are on the agenda, as witnessed by the G7 and NATO summits and the recent ban on Chinese stocks by US authorities.
- 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.
Recent actions in the asset allocation strategy
After a first quarter buoyed by hopes of an end to the health crisis, positive equity performance, negative bond performance and strong outperformance of value and cyclicals, investors showed less conviction in the second quarter. US yields peaked at the end of Q1, and both equities and bonds posted positive returns in Q2 in much lower volumes. We expect positive returns, but at a lower level, with much higher sensitivity to bond yields’ evolution. Ahead of summer, we 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 recently decided to take profit on our European tilt. We are now neutral Europe and thus neutral equities. We are keeping hedges against higher yields and inflation and some derivative protections. We have identified various possible catalysts (o/w delta variant and oil prices) for an equity market correction from which we might take advantage during the summer.
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 a balanced approach to assets related to the post-COVID rebound/recovery and longer-term growth beneficiaries.
We have a neutral stance on equities, with a preference for ex-US equities and are underweight bonds.
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 basket that includes currencies, such as the AUD, the CAD and 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 are buying 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 US10Y yields to rise from current levels. - 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.
