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Global Investment Views - March 2020

 

 

 

Auteur 1

 

 

 

 

 

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Modest risk reduction, looking for entry points

The spread of Covid-19 outside China has rattled risk assets in the recent trading sessions. Investors triggered some profit taking in markets, which reached historical highs and even broke psychological thresholds in previous weeks. The atmosphere of fear has remained consistently high only in the so-called safe assets — the USD, UST and gold — signaling that investors have been looking for effective hedging strategies. Our central scenario is for a temporary deterioration of the global economic picture in Q1 of this year, with some possible spill over into Q2, given that weaker-than-expected global trade growth is ultimately affecting industrial production and manufacturing activity and there are some impacts on the internal demand. Later on, we should see a recovery over the remainder of the year. Overall, we have downgraded global growth to 3.0% from 3.2%.

Clearly, the main risk now is the unwinding of recent market complacency and the reaction of “animal spirits”. The good run in risky assets has been driven by investors who believe (1) the Covid-19 episode will be temporary (our central scenario); (2) a worsening situation will trigger more Central Bank (CB) action; (3) they have no alternative, given the moves of safe-haven assets. Therefore, we can expect to see some profit-taking, short-term market volatility and overreaction.

A tactical move towards neutrality in risk exposure and an increase in hedging looks to be a good strategy to navigate this phase. Beyond that, Covid-19 must be seen as a way to implement our investment convictions, exploiting entry points in some areas of the markets such as the cyclical value component in European equities (already attractive, but even more so now), EM equities (help-yourself-countries or domestic-demand stories) and EM currencies. All these stories will be back in focus once the virus-headlines recede. In addition, falling core yields will likely reignite the search for yield in credit or in higher-yielding government bond space in EM and DM (e.g. Italy). We should also not underestimate the fact that if the situation worsens, CBs and governments could start to use stimulus on a massive level, renewing the narrative of bad news is good news. Fed’s recent inter-meeting emergency rate cut of 50 bps is a step in that direction.

As main areas of risk and opportunity lie in credit, the main question for investors is: To what extent will the coronavirus generate non-idiosyncratic disruptions? We expect resilience in the credit market, in particular EU IG, but we expect divergences between good quality names and bad quality names, which could come under stress. This reinforces our view of an increased scrutiny in credit, focus on bottom-up research and a rise in attention on liquidity.

From a long-term perspective, coronavirus reinforces some pre-existing trends:

  • De-globalisation and retreat in global trade should support insulated investment themes, such as domestic-demand driven EM countries or a focus on more domestic real assets.
  • Low interest rates at equilibrium. Core US bonds are providing a cushion for risky assets in reaction to setbacks, but they are also leading the rebound of risky assets. It follows that duration management must be asymmetric: it is much more risky being short duration than long duration, and there is a clear hedging-role for US Treasuries. In this scenario, the interest rate factor dominates the growth and earnings components of equity returns. Investors should be alert to the early signs of either a change in equilibrium rates or a shift pointing to more prominence for the real component of returns versus the monetary component, but we are not yet at this point.
  • Demand for real assets. The absence of real illiquid assets is a recurring weakness as they represent an already large, but rising component of relative value plays. De-globalisation is driving demand for real estate on the basis that it provides significant international geographical diversification. The search for a better remuneration of the interest factor (infrastructure) or simply equity-like returns with bond features is also driving demand. This mismatch in supply and demand, along with trade and pandemic noise, can only accentuate this sort of safe-haven status with fast rising complacency.
Flag-UK

March 2020

Flag-FR

Mars 2020

 

Author 2

The economic fallout is likely to prove transitory — albeit profound and impactful — as long as the virus spread is contained and activities can
resume over a reasonable time horizon

 Coronavirus impact on economy and markets

Since the virus outbreak started, governments have implemented restrictions on travel to China and many activities have been shut down. This will affect both Chinese and global economic outlook in Q1. We have consequently downgraded our 2020 growth forecasts for China and the main DMs. We believe that such economic fallout will prove transitory — albeit profound and impactful — as long as activities resume in a reasonable time frame. Chinese authorities and many Central Banks (CBs) in EM have already loosened monetary policy and announced more fiscal stimulus to help their economies weather the virus fallout. We expect this shock to spillover to China’s Asian trading partners, causing temporary disruptions to the supply chain, followed by a rebound and growth stabilisation at potential.

Global trade and GDP growth will be the main casualties of such idiosyncratic shocks, along with those economies that are more open to external trade, such as Eurozone countries -- Germany and Italy above all. For instance, Germany’s exports to China as a share of GDP were 2.8% in 2018, the highest share of any Eurozone country. Conversely, the US economy should prove more resilient thanks to its strong domestic demand (its exports to China accounted for only 0.6% of GDP in 2018). We also expect to see a hit to confidence indicators, with lower global PMIs eventually hitting earnings formation.

In our revised base scenario, the expected rebound in the global manufacturing sector only gets delayed. Operational hurdles will affect the automotive and energy sectors and the Q1 reporting season could deliver below-expectation results. Financial markets still rely on CBs’ ability to support economies under difficult circumstances. Such a scenario remains mildly supportive of risk assets. Since uncertainty on virus-related developments is high, we stress our central scenario, with China’s economic recovery proving slower than expected and the virus fallout more persistent. Global trade would contract by 2.0%, entailing significant supply chain disruptions and causing a 2.3% contraction in US industrial production in 2020. In the Eurozone, the drop is likely to be larger — at 3.3% — with Germany and Italy heavily hit. In the longer run, Western corporations might insource activities from China. Under such circumstances, the stall in economic activity would cause a plunge in confidence indicators and tighter financial conditions.

Based on historical evidence, we modelled the fallout of a four-point (or higher) drop in the global manufacturing PMI for a quarter, followed by a rebound. Such developments would cause a 4.8% fall in US equities and around 7.4% for Japanese and European equities. If this is the case, in the last few days the market has probably overshoot on the downside (our base scenario at the moment) or it has started to price in a darker scenario, under which the downside move would continue.

Finally, we built a downside risk-off scenario in which the efforts of Chinese authorities to restart growth falter, China’s 2020 GDP slows to 4.9% YoY — rather than 5.6% as outlined in our revised base scenario — and the global economy moves into recession. In addition, as new virus hotspots are emerging in Europe, we have included in our analysis an endogenous slowdown of Italy’s economy where cities are put into quarantine and activities are shutdown to contain the spread of the virus. Italy might experience a recession this year, as affected areas account for about 40% of its GDP. Should similar occurrences be seen in other European countries, we would need to review our forecasts accordingly. In that case, the global economy would experience a supply as well as a demand shock to both the manufacturing and the services sectors and US GDP growth would be barely positive this year, while both Eurozone and Japan’s GDP would contract. Financial risks would rise, along with a spike in default rates and distressed ratios and tightening of financial conditions. Corporates would experience contracting EPS growth – our estimates are for a 6% EPS contraction in the US and an 8% contraction in the Eurozone. CBs may have to jump in with emergency liquidity injections. The US Fed would cut rates by 75 bps (50 already cut) and global CB balance sheet expansion would hit 4%. In Asia, fiscal authorities will likely support the outlook with a massive fiscal expansion aimed at restoring both production and consumption trends. However, some countries have limited room for manoeuvre and may not be able to put in place powerful countercyclical tools. In such a scenario, we would switch to a defensive asset allocation and European equities may suffer as poor Q4 results would be intensified by new hurdles related to the virus outbreak.

For now, we estimate a low probability that this scenario will materialise.

titre-multi-asset
Author 3

 

In search for
protection from
continued market
volatility, we
moved to a lower
risk stance and
would look for
more favourable
entry points
when visibility
improves.

  Time to reduce risk, but be prepared to re-enter

Our fundamental view on the stabilisation of global growth around potential has not changed and we believe the continued active role of monetary and fiscal policies will support this. However, the spread of Covid-19 beyond China into other areas in Asia, Europe and America could have an impact on demand and this is now reflecting in asset prices. As a result, we have become more cautious on risk assets to accommodate these possible events. Having said that, our strategy is to stay vigilant and monitor fresh data to better assess the effects on the global economy

High conviction ideas

Given this volatile environment, we moved to a lower risk stance and recommend investors to keep risk at low levels in their portfolios. Derivatives have been a good tool to safeguard against further downward movements in European and US equities. Overall, we are now negative on these markets. These actions are tactical in nature, and driven by risk management considerations in order to try to protect investors’ portfolios from short-term volatility. In EMs, we have removed our positive view on China and the relative preference for Korea vs GEM as these are among the most directly (and indirectly) affected areas by the spreading of the virus. Nonetheless, we remain ready to reconsider our stance on the EM equity asset class once the situation calms down.

In fixed income, we are more constructive on duration in Europe and the US as this is also an hedge in case of further volatility in the market.

We maintain our relative preference for 5Y UST vs Germany 5Y, owing to stronger safe-haven demand for the former and given that the Fed has more scope to cut interest rates than the ECB, as reflected in the recent comments by Ms. Lagarde. The Italian BTPs remain a search for yield strategy, where we see some short-term pressure if the markets start discounting an economic recession and also if investors start to book profits from their long market positions. However, we prefer a wait-and-see approach amid favourable technicals, relative value and lower political risks. BTPs continue to offer attractive yields (compared with similar-rated sovereign and corporate bonds). We maintain our relative preference for Italy 30Y vs Germany 30Y.

Credit is attractive, particularly in Europe, supported by technical factors, inflows and the ECB’s quantitative easing programme. However, we believe it’s prudent to protect credit exposure through derivatives in case there is a sell-off as witnessed in equities recently. We prefer EUR over US in both IG (lower leverage in EUR) and HY (better quality in EUR and lower exposure to the energy sector). In EMs, attractive carry, subdued inflation and dovish EM central banks are supportive of EM debt, where we prefer HC over LC. However, we suggest partially hedging the duration and currency risk.

On FX, while we believe the effect on Chinese growth should be transitory, the virus outbreak could have negative consequences for EM currencies. Accordingly, we are more cautious now and have temporarily removed our positive stance on EM FX. In DM, EUR/USD moved lower, given that the US economy appears to be less exposed to external risks. This extreme movement has already started to reverse. However, the strength of the USD could last for some time as growth concerns in Europe are expected to continue and interest rate differentials are also in favour of UST. Therefore, we prefer to move to a neutral view on EUR/USD and monitor market conditions to reassess this view.

 

Risks and hedging

The virus impact, high market expectations regarding central banks policies, and the evolution of the Brexit transition process are all risks that could cause volatility. We recommend hedges such as gold, UST and the Japanese yen to safeguard investor portfolios.

Tableau 1

Source: Amundi. The table represents cross-asset assessment on a 3-6 month horizon, based on views expressed at the most recent global investment committee. The outlook, changes in outlook and opinions on the asset class assessment reflect the expected direction (+/-) and the strength of the conviction (+/++/+++). This assessment is subject to change. USD = US Dollar, UST = US Treasury, DM = Developed markets, EM/GEM = Emerging markets, EM bonds (HC) = EM bonds hard currency, LC = Local currency, FX = Foreign exchange, IG = Investment grade, HY = High yield, NOK = Norwegian krone, CB = Central banks, CHF = Swiss franc.

titre fixed income
Author 4

 

  High selectivity in credit, but there are opportunities

With elevated uncertainties on the macro side and investors’ continued search for safety, we expect the core government bond yields to remain very low, with limited upside pressure. Negative yielding debt is back to US$14tn in value and this continues to push investors towards the ‘oasis of yield’ in credit, securitized assets and peripheral debt.

Here, a close look at the evolution of the macro economic situation is crucial. While abundant macro-liquidity supports financing of corporations, a deterioration of the economic environment could affect the most leveraged areas of the market.

DM bonds

In global fixed income, we maintain a slightly positive bias on duration, with a preference for the long end of the curve and flattening. We continue to prefer US, despite some profit-taking, as safe-haven demand is likely to support UST. Elsewhere, we have a short to neutral stance on core Euro duration (negative on Germany) and a short one on Japan and the UK as fiscal stimulus is likely to push rates higher and the BoE is likely to keep rates on hold. EU peripheral countries continue to offer attractive yields and we are constructive on Italy. Investors can also play curve flattening opportunities in Euro peripheral areas and steepening in the UK. Credit remains an area of opportunity for us but selection is crucial. EUR IG has been resilient and we continue to prefer it vs US IG as the former should benefit from the ECB programme, in particular in the subordinated debt financial sector. In HY, EUR remains our favoured pick over US. Overall, we suggest investors to partially reduce the credit exposure to make room for additions in the future.

In the US, solid economic data and corporate earnings have helped propel credit spreads to near all time tight levels before coronavirus risk erupted. Tail risks to economic growth remain, potentially weighing on credit fundamentals. As a result, we are cautious and selective overall. In US credit, while we realise that prospective returns from securitized credit would be lower after last month’s strong performance, we continue to favour securitized over unsecured due to the former’s better risk/return profile. Structured securities, including non-agency RMBS and consumer debt, remain attractive vs most other IG sectors. Given that employment, wealth and confidence are strong, and as fundamentals in the housing market remain positive, low mortgage rates should boost home sales, prices and affordability. Spreads in the agency MBS are attractive, but their potential for further tightening is limited owing to the net supply impact of the Fed’s dwindling MBS holdings.

EM bonds

We remain constructive on HC bonds, notwithstanding the risks from the coronavirus and the US election cycle, as the technical backdrop remains favourable and monetary policy easing along with fiscal stimulus should be supportive. We prefer select high-yielding names such as Indonesia, Ukraine and South Africa. In LC, we think valuations have become less attractive and there will be some negative impact from currency weakening. Nevertheless we continue to see pockets of value, especially in frontier markets.

FX

We maintain our cautious view in aggregate on EM FX, particularly regarding currencies more exposed to a further slowdown in Chinese growth and currencies of commodity exporting countries such as Thailand and Chile.

In a world of falling yields, investors should look at credit and peripheral bonds as a source of yield, but also leave some space for further addition in areas where price dislocation could arise

Graphique 1

EM FX = Emerging markets foreign exchange, HY = High yield, IG = Investment grade, EUR = Euro, USD = US dollar, UST = US Treasuries, BoE = Bank of England, RMBS = Residential Mortgage Backed Securities, HC = Hard currency, LC = Local currency.

titre equity
Author 5

  Volatility will reinforce bottom-up selection

Overall assessment

There is an elevated uncertainty regarding the short-term outlook for global equities. The coronavirus outbreak will weigh on economic growth this quarter and next. There is some political risk — underestimated in case of US election — and the expected earnings rebound will likely be postponed. Despite this short-term challenge, we expect the economy to rebound once the most acute phase is over. Moreover, the dovish stance of central banks and fiscal stimulus should support a manufacturing stabilisation and improvement in the outlook for equities. It’s important to note that US markets, in general, are more defensive in a weak environment for equities. But as soon as the situation stabilises, investors who are cautious in this phase, should exploit opportunities in the most dislocated areas of the market (EU and EM equities). Bottom up selection is extremely important, to navigate the markets in this phase.

DM equities

In European equities, we did not change our main conviction that price dislocations in the cyclical value space are an opportunity for bottom up investors. For the overall market, due to the deterioration of the economic outlook, earnings growth is critical for future performance. The situation in China has created new headwinds and a completely accurate assessment of its potential impact is not easy. We have used market volatility to favour companies where we are convinced about strong balance sheets and resilient business models. At a sector level, we have become more positive on banks and industrials among cyclicals, and health care among defensives, and we are less positive on energy. We believe markets are expecting too much from the IT and consumer staples sectors, making us cautious in these areas.

In the US, we think markets are too optimistic about the macro-economic situation and underestimate the political risk. Although an earnings rebound will likely be delayed, earnings should eventually improve later in 2020 on the back of lagged effects of lower interest rates and input costs (lower energy prices). This would benefit the consumer-dominated US market. Higher earnings are likely to support our conviction of cyclical value outperforming growth, but this should happen only when the manufacturing recovery materialises. We are cautious overall on the market at the moment. At a sector level, we favour relatively conservative (less cyclical) cyclical names in financials and industrials. In healthcare, we realise that the meaningful discount that existed in the sector when candidate Elizabeth Warren’s chances peaked last summer has now corrected and value is no longer obvious, especially with drug pricing legislation likely to come up soon in US Congress. We are cautious on IT (expensive valuations), consumer staples and utilities sectors.

EM equities

We are selectively positive on EM equity with a medium term perspective. We focus on companies related to domestic consumption that are relatively insulated from the coronavirus story and those that can potentially benefit from strong domestic demand or the continuing shift in the value chain (Russia, Indonesia, Vietnam). On the other hand, we have become very cautious on Chinese tourism-related sectors such as hospitality, aviation and consumer discretionary. In this regard, we are defensive on companies listed in countries such as Thailand, Korea and the Philippines that are beneficiaries of demand from Chinese tourists.

Our core convictions have not materially changed in Europe, but we have modified our stance to take into account US election risks and the global virus threat

Graphique 2

IT= Information Technology

 

 

Asset Class View

Source: Amundi, as of 3 March 2020, views relative to a EUR-based investor. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research, investment advice or a recommendation regarding any fund or any security in particular. This information is strictly for illustrative and educational purposes and is subject to change. This information does not represent the actual current, past or future asset allocation or portfolio of any Amundi product. IG = Investment grade corporate bonds, HY = High Yield Corporate; EM Bonds HC / LC = EM bonds hard currency / local currency. WTI= West Texas Intermediate. QE=quantitative easing.

 

Definitions

  • Credit spread: differential between the yield on a credit bond and the Treasury yield. The option-adjusted spread is a measure of the spread adjusted to take into consideration possible embedded options.
  • Cyclical vs. defensive sectors: cyclical companies are companies whose profit and stock prices are highly correlated with economic fluctuations. Defensive stocks, on the contrary, are less correlated to economic cycles. MSCI GICS cyclicals sectors are: consumer discretionary, financial, real estate, industrials, information technology and materials, while defensive sectors are consumer staples, energy, healthcare, telecommunications services and utilities.
  • Duration: a measure of the sensitivity of the price (the value of principal) of a fixed income investment to a change in interest rates, expressed as a number of years.
  • ECB: European Central Bank
  • FX: FX markets refer to the foreign exchange markets where participants are able to buy and sell currencies.
  • Liquidity: Capacity to buy or sell assets quickly enough to prevent or minimize a loss.
  • MOVE: MOVE Index is the Merrill Lynch Option Volatility Estimate for the US Treasury.
  • QE: Quantitative easing (QE) is a type of monetary policy used by central banks to stimulate the economy by buying financial assets from commercial banks and other financial institutions. QT: Quantitative tightening is the opposite of quantitative easing.
  • Sovereign bond: A sovereign bond is a debt security issued by a national government.
  • VIX: VIX is the CBOE volatility index. The VIX index is a measure of market expectations of near-term volatility on the S&P 500 (US equity).
  • Volatility: a statistical measure of the dispersion of returns for a given security or market index. Usually, the higher the volatility, the riskier the security/market.
  • Yield curve flattening: A flattening yield curve may be a result of long-term interest rates falling more than short-term interest rates or short-term rates increasing more than long-term rates
  • Yield curve steepening: This is the opposite of yield curve flattening. If the yield curve steepens, this means that the spread between long and short term interest rates widens. In other words, the yields on long-term bonds are rising faster than yields on short-term bonds, or short-term bond yields are falling as long-term bond yields rise.
BLANQUE Pascal , Group Chief Investment Officer
MORTIER Vincent , Deputy CIO, Asia ex Japan Supervisor
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Global Investment Views - March 2020
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