Uncertainties will most likely peak in the next few weeks. We expect financial markets to continue to struggle to find a clear direction as we oscillate between the very defeatist news of a second wave and the high hopes of a near-term vaccine that the Food & Drug Administration (FDA) could approve in a heated US presidential election context. Our asset allocation remains prudent with an underweight equities and protection via options. We acknowledge the resilience of certain countries and sectors in the current context and the upside potential, in the mid-term, of the themes that will benefit from a relief rally upon the announcement of an approved vaccine.. Countries have become more knowledgeable about the virus and a vaccine is in the pipeline of several pharmaceutical companies.
Uncertainties peaking in October
October and November 2020 are anticipated by investors as volatile months.
In the US, we are in the last month prior to the presidential elections that will take place on November 3rd. Historically, there has always been more market volatility around election time. This year, it is expected to spike around the D-date and to last longer than usual. The term structure of volatility, i.e. the curve depicting the differing implied volatilities of options with the same strike price but different maturities, reflects the market expectation on the future implied volatility. Today, it factors in a prolonged post-election uncertainty.
In the aftermath of the first presidential debate that took place last week and the presidential couple testing positive for COVID-19 also last week. The odds in favour of a Blue sweep have risen, making it, for the first time, the most likely outcome. In the meantime, there is still no agreement on a fiscal package.
Senior White House officials and congressional Democrats have recently exchanged words over the president’s sudden withdrawal from talks on a new economic relief package. Assuming that the pre-election fiscal stimulus negotiations were to resume, the president would have to sign the package into law no later than Monday, October 19th for stimulus cheques to start getting into pocketbooks in time for Election Day.
Also, in Europe, October is a decisive month. First, because of Brexit, and second, because a few EU countries see their COVID-19 cases again rapidly increasing.
The European Union and the UK have to find a way to negotiate the terms of Brexit. The most recent news flow was slightly more positive and both parties have reiterated that they would like to avoid a damaging “no-deal” scenario. The 3 most contentious issues have been fisheries, fair competition guarantees and ways to settle future disputes. A lot is at stake, as the bilateral trade between the EU and the UK alone is worth trillions of euros. Needless to say, both investors and businesses are increasingly anxious about a split with no agreement in place to ensure the continuation of trade without tariffs or quotas.
Again re-the European Union, the area is headed into a non-synchronized recovery and increasingly divergent regional equity market performances. A few countries see the epidemic about to run out of control and new stringent measures are being taken, whereas others have managed to stay on the safe side.
Resilience
In the midst of all the uncertainty, economic growth is broadening and low inventories should continue to support PMIs over the coming months. But it is also softening, and a flatter rebound into year-end and 2021 is expected from here. Noteworthy is the uneven pace of recovery between regions. The most obvious divergence is between:
- Germany vs. Eurozone
- China vs. Rest of the World
Indeed, some countries and sectors have stood out for their resilience in this context, either because they are managing the sanitary crisis well or because they are benefiting from changes in lifestyle. Those changes will not be just for the short term. In fact, it is likely that the COVID-19 crisis will have long-lasting effects on companies and countries. The gap between the relative “winners” and the “losers” has widened and will continue to do so.
In Europe, for instance, there is a growth gap between, on the one hand, Germany, and countries that have better managed the sanitary crisis and, on the other, France, Spain and Italy, where the management of the pandemic has shown some flaws.
Also, China has stood out. Unlike all other major economies, China has recovered quickly from its COVID-19 shock. Past the peak of February 17th 2020, they have not had any new COVID-19 infections. They will post positive economic growth in 2020 and 2021. Their stock market has performed well, as their equities are levered to technology. Today, Chinese new orders and Korean exports are at their highest level since 2018. Asian consumption and exports are driving rising global EPS and expanding global PMIs.
In terms of portfolio management, it makes sense to retain exposure to the “post-COVID-19 world” thematics. We have identified several, including:
- the tech sector
- online services
- government spending recipients
- the health care sector
When it comes to countries, our current allocation includes a preference for:
- Germany
- China
More can be found in the last section on our current multi-asset strategy.
Relief rally
Given the health emergency, the resources committed to pharmaceutical research should make it possible to develop a vaccine in record time. Research shows that several pharmaceutical companies are in the race and the top 3 are already in the trial phase. 3 COVID-19 vaccine candidates could be approved by the end of the year / beginning of next year. The next step in the fight against the virus hence consists in obtaining approval from the US Food & Drug Administration (FDA) for one of the vaccines in trial phase. The administration only approves vaccines that have a minimum 65% efficiency rate. The current situation is only challenged by the fact that we have never developed a vaccine against coronaviruses, and questions remain about the possible duration of immunity.
With a vaccine that is available and can be commercialized, financial markets will rapidly price in an exit to the sanitary crisis. This should trigger a partial catch-up of companies and assets that remain heavily impacted by the epidemic.
We are exposed – or are strengthening our exposure – to specific companies that will benefit from the “re-opening” of economies. In order to benefit from this relief rally, these include:
- Eurozone equities including a specific exposure to Eurozone banks
- Emerging equities Emerging debt in local currency – while being short USD.
Our current multi-asset strategy
Our overall equity exposure has stayed slightly cautious, and we are continuing to protect European and US equities via options and portfolio hedges (gold and JPY) as we currently find the markets less directional.
We are keeping our exposure to the most resilient themes and countries. In terms of countries, China and Germany stand out. In terms of sectors, Tech and Healthcare stand out. We are keeping our exposure to the “vaccine relief rally” by being overweight Eurozone equities (including a specific exposure to banks), emerging debt in local currency.
We remain neutral UK equities, which, although having lagged the rebound, should benefit from a possible last-minute Brexit deal.
Our bond allocation has stayed stable and remains positive on credit Investment Grade (Europe and the US) and emerging debt .
We have taken some profit on emerging debt in hard currency that posted a strong performance since April (when we increased our exposure close to the bottom of the market).
We are also maintaining a short duration bias, an underweight exposure to government bonds in Europe (on core countries) and an overweight in peripheral European bonds.
Our currency allocation is short USD vs. EUR, short USD vs JPY and long NOK vs EUR.
