Multi-Asset Investments Views - June 2020 - The speed and shape of the recovery
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Our key convictions:
- Positive on Credit – Unprecedented support from both fiscal and monetary authorities should help to ease valuation and liquidity concerns
- Neutral on equities - Global economy is set to collapse in 1H20, with massive negative impact on earnings, but the foundation for a growth bounce in the 2nd half is being laid
- Neutral duration on government bonds - monetary arsenal is a clear support for bonds, but unparalleled fiscal stimulus and eventually unprecedented supply should maintain government bond yields in the current range
- Positive on Credit
- Neutral equities
- Neutral duration in our government bonds exposure
- Long equity call options delta hedged to protect the portfolios where possible
As many parts of the world slowly deconfine and gingerly reopen parts of their economy investors are focused on the pace and nature of the recovery. The speed and shape of the recovery will have a profound impact on the way various asset classes behave over the next couple of months.
After the volatility of March and early April, markets have been a little calmer over the last month. However underneath the surface there are huge divergences. Specifically, the valuation and performance dichotomy between Defensive/quality growth (i.e: Consumer Staples;technology) and value/cyclicals has never been wider. There is a good investment opportunity here, but timing is crucial.
We maintain our medium-term constructive view as the policy response to the pandemic is aggressive but at this stage the shape of the recovery is uncertain. We think that high frequency indicators such as the labour market and surveys will be valuable in ascertaining the bottom up activity. Chinese data suggests that activity is picking up but more so in the construction and industrial sectors than the service sector. US corporate surveys that we follow suggest that the trough in activity took place already 5 weeks ago and that since then consumer sectors have led the improvement (Auto dealers, retailers, restaurants and even airlines see a slight pickup in bookings). It is still early days in the Eurozone and macro data/survey data suggests that we are solidly in the downturn.
There is much talk of a U shaped or a V shaped recovery. Despite the bounce in equities since the March lows, investors seem more positioned for the U as interest rates stay low, value and cyclical stocks crushed (cf. chart below) and sentiment and positioning is bearish. A V shape would suggest better performance from High Yield, commodities, cyclicals and higher inflation expectations which is not the case now. In any case the next few weeks will give valuable signals as to the shape and strength of the recovery.
The Covid 19 crisis has also put incumbent Governments under pressure and accelerated to the surface any of the underlying global tensions. In an election year, US-China recent truce could be seriously tested. Expect to see the aggressive rhetoric increase and targeted policy action. Latest in the target line is Huawei where the Trump administration would dearly like the group to be excluded from using US technology (mainly semiconductors). Moreover, Brexit was on the sidelines whilst the focus was on fighting the pandemic but progress on negotiations is poor to say the least. The resurgence of these various pressure points could again lead to bouts of market volatility. However on Monday, we had constructive news in the Eurozone. France and Germany presented a 500 Billion Eurozone recovery fund proposal to be integrated into the EU Budget. It is early days, but this is the first hint of a shared spending plan to underwrite the recovery.
Regardless of the speed of the recovery there are some asset classes which look to us to be very attractive. Specifically, Corporate Credit which is well supported by Central Bank purchases and QE. Default rates should obviously rise sharply from their lows but should remain still well of the GFC peak and in this environment seem to us attractive. We overweight in our portfolios. The primary markets is still the most liquid but the secondary market is also now less stressed.
Our portfolios are currently neutral equities. Our models suggest that consensus earnings have not adjusted enough relative to the collapse in PMI’s. Either forecasts are too optimistic or PMI’s too negative but there is a disconnect. Investors have largely written off earnings for 2020 and the focus is 2021 – consensus is for growth of 20%+ but until we get a better idea of where growth in 2020 settles. To move meaningfully higher, we need confirmation of a pickup in data, if only data that is less bad than investors fear. It could be that the next move is a sharp rotation away from quality growth stocks which are widely held and a bounce from bombed out cyclicals. Watch this space.
We also like the Yen versus USD as we think the risk is tilted toward a stronger Yen and a weaker dollar into year end. There is virtually no difference in the GDP growth declines this year in Japan versus the US, implying a convergence of GDP growth on the downside and the end of US growth exceptionalism putting some pressure on the USD. The speed, scale, and content of government and central bank policies. The difference in pace of balance sheet expansion between the BoJ and the Fed is huge and could thus increasingly lean in the direction of JPY strength at a time when the JPY is largely undervalued, and the USD overvalued. At last, one of the best long-term hedges for an additional growth shock from COVID 19 second wave is the yen which typically appreciates in a risk off environment.
Investors remain cautious as interest rates stay low and value stocks crushed
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This document is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments as per MIF Directive (2014/65/EU), nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities.
Due to its simplification, this document is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this document is provided based on our state of knowledge at the time of creation of this document. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.
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