Multi-Asset Investments Views - July 2020 - Back to work
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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
- Positive on equities - most countries have reopened on or ahead of schedule. As a result, economic data point to a faster and stronger initial recovery than initially thought while equity valuations are supported by unconditional monetary support
- 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
- Positive equities
- Positive commodities
- Neutral duration in our government bonds exposure
- Long equity call options delta hedged to protect the portfolios where possible
The major drivers for risk assets currently are positive economic surprises, a backdrop of easy money/ loose monetary conditions, and high cash balances/ low positioning. All of these factors are now supportive and as a result we decided earlier this month to upgrade equities and commodities to overweight in our portfolios.
Since we published our Multi-Asset Investment Views last month, most countries have reopened on or ahead of schedule, particularly in the US and this reopening process is gaining momentum. As a result, economic data in the US points to a faster and stronger initial recovery than initially thought which creates possible upside risks to the consensus growth forecasts. The strength of the recovery in the labor market surprised across the board as the latest US jobs report showed a fall in the official unemployment rate to 13.3% (a 3.2% decline from 16.3% when correcting for misclassifications), far below the consensus 19.0%, suggesting that the jobless peak has already passed. On the back of this positive jobs report, May retail sales jumped 17.7% MoM, leaving retail spending down only -6.1%YoY in May relative to -19.9% in April - strengthening the idea that government income substitution, along with a large share of job loss being temporary, would allow for a strong bounce-back in spending. While history will judge if it is wise to replace 1 dollar lost by households with more than 2 dollars from the government, part of this money is likely to be spent at some stage as the saving rate should come down from an unsustainable 33% level. Unless data surprises move negative or economic data momentum fails to turn higher over the next three to four weeks, risk sentiment is likely to remain constructive.
Of course, many service sectors are likely to remain impaired for some time. Restaurants, retail stores, hotels, movie theaters and airlines won’t return to full capacity quickly. However, these sectors are significantly under-represented in US equity indices like the S&P500 which, on the contrary, is heavily skewed toward the technology (27% of the index market capitalization), Healthcare (14%), Consumer Staples (7%), retailing (8%) and Utilities (3%) sectors. Taken together, these sectors account for 60% of the S&P500 market capitalization and are amongst the least impacted by the lockdown, with limited expected impact on their earnings this year. This is the reason why we think earnings per share are likely to be back to their pre-crisis level before US GDP, around Q2 2021 versus Q3 2021 for GDP. At that time, equity valuations could well be higher than their pre-crisis level given the unconditional support of monetary policy and the resulting decline in the equity discount rate. If you add the relatively light positioning, the path of least resistance seems to be up for equities.
Of course, faster reopening also means rising risks. An up-move in COVID-19 infections in some US states triggered anxieties about a second wave and corrections in some markets earlier this month. However, having favored public health over the economy in March/April, policymakers’ preferences have changed. The threshold for reversing the reopening is a lot higher than the threshold for the original shutdown. The question is about tolerance level, which will vary by state and country as a function of treatment capacity. Officials are likely to treat second waves with just local lockdowns and economic consequences should therefore not be large enough at this stage to justify a defensive investment strategy. We are obviously following developments very closely and are prepared to adjust our stance if necessary.
On the political front, US equities have continued their march higher despite Joe Biden gaining in the polls. We don’t think that this is an immediate macro mover but certainly one to watch heading into Q3 as Joe Biden has proposed reversing half of the Trump tax cut. Using the 2017-18 experience as a guide, if implemented immediately after the elections - which supposes Biden wins with Democrats taking both houses of Congress - this would shave roughly 5% off 2021 EPS of S&P500 companies which could act as a catalyst for stocks to decline. As of now, we are less concerned given our confidence that other Democratic policies could remain supportive of the economy (e.g. House Democrats unveiled a 1.5 trillion USD infrastructure package), and the limited downside to profits from a half reversal.
After having massively surprised on the downside, economic data are now significantly surprising on the upside
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