Early Christmas gifts to support year-end rally
As we approach year-end, markets can count on two pieces of news to propel some optimism. The first comes from the US, where the Biden victory, without a real Blue Wave, is seen by markets as the best possible outcome. A Republican, or even a 50-50 senate, would make it very hard for the new president to pass any extreme measures in terms of fiscal push, more drastic legislation or tax increases. The other positive news came from Pfizer/BioNTech and Moderna, regarding the high efficacy of their vaccines, while other trials are also accelerating.
However, both news bring some shadows as well. Markets are underestimating that Biden will have to concede something to the more radical section of his party. On vaccines, we need a confirmation from the scientific community that they work. In addition, development of vaccines for a large portion of the population is challenging. The most likely scenario is one of
The Biden victory has reduced (but not eliminated!) political risk and this is positive for markets. On foreign policy, we can expect a tendency towards a multilateral approach, which is good for Europe. The risk of trade tariffs on the auto sector has significantly receded. However, on China, we doubt that the relationship will become very soft. The Democrats also view China as a challenge, but the tone will be less harsh than with Trump. Competition with China will remain especially on the tech front, but it is likely that Biden will take a more strategic approach. With Iran, it is likely that he will use diplomacy to pursue a new nuclear deal and de-escalate tension. A positive consequence is that with Biden, we can see a re-acceleration of the ESG thematic, climate and social equality. The debate these days is if the Fed should take a more explicit step towards fighting inequalities, as a third leg of its mandate, and that would be a big change. We could expect further improvements from American corporations in terms of ESG adoption. For investors, this means that the long-term theme, of Asia growth propelled by China and the US focusing on innovation and ESG, would be reinforced.
With a cyclical view, entering 2021, we see the recovery phase approaching, though still within a regime of low rates and abundant liquidity. This, in our view, will support risk assets and equities in particular with a rotation of themes, looking for cyclical opportunities and a recovery in the unloved value sectors. EM will likely benefit from a high growth differential vs DM, especially in H121, when Europe and the US could still be affected by the second wave, while the virus cycle is improving in the southern hemisphere and China continues on its recovery path. This, coupled with a still weak USD, bodes well for EM bonds and EM FX, where selection remains important. In FI, corporate bonds are supported by abundant liquidity, but their relative appeal vs equities is diminishing as we move towards a recovery phase. In addition, defaults in low-rated securities will continue and many companies will not survive. So, on credit, we believe it is not the time for a blind call, but investors should reinforce their focus on credit research in a search for quality companies, with solid business models. Governments bonds (Treasury and core Euro) remain unattractive and should be considered mainly for liquidity/hedging. In conclusion, we believe that it is too simplistic to give in to unbridled optimism: we are likely to see some tough months ahead. Focus on hedging and liquidity should remain in place, because the path towards stronger growth will not be linear. However, we believe that the adjustment phase could offer some opportunities to re-adjust portfolios towards new themes.