We have downgraded our growth forecasts for this year, but upgraded the numbers for 2021 driven by a stronger base effect. We believe inflation will be subdued in the short-term, but will pick up next year. |
Growth and inflation expectations post Covid-19The ambiguous and unprecedented nature of the crisis has made economic forecasting difficult, underpinning the need for updates as fresh data comes to light. We have slightly downgraded our growth forecasts for this year but upgraded the numbers for next year. On the other hand, we believe inflation will remain subdued this year, with an uptick in 2021. Official Q2 GDP data is now available, and therefore it is possible to properly assess the lockdown-induced economic contraction and reassess from the up-to-date starting point, the future economic outlook. Global GDP is now expected to contract by between -3.5% and -4.7% y-o-y (prior estimates -2.9% to -4.2%), led by downgrades in several countries. It is worth mentioning the downgrade for the UK and a few south Asian economies (e.g. Malaysia, Philippines) where Q2 GDP came in weak. The 2020 downward revision will trigger a stronger base effect in 2021: we therefore mildly revised upwards our GDP growth forecasts for next year to 4.4-5.7% (vs 4.1-5.1% previously). On the downward revision, we also confirm a slower recovery path in the second part of Q3. After a robust post-lockdown rebound in activity starting around May and early June, the pace of recovery seems to have slowed and stabilised between July-end and August, and this is visible in both soft and hard data. The recovery curve based on HFD gauges of production activity, the labour market and consumer sentiment* has begun to flatten almost everywhere, without reaching pre-crisis levels, with very few exceptions. After the losses experienced in H1, the Q3 recovery does not seem to be enough to bring the majority of economies back to their pre-crisis levels any time soon. The bottom has passed, but economies do not seem to be climbing out of it quickly enough to ensure a fast healing. In our view, economic performance will progress along a gradual upward sloping catch-up process. In the central scenario, this translates into pre-Covid-19 levels not being reached before several quarters from now, on average, with the exception of China, which will likely reach an end of 2019 growth level by end-2020 (see chart). A vaccine, expected by many analysts by mid-2021, would prevent temporary damages from morphing into long-lasting losses and would support the recovery via stronger confidence on households and businesses. In the meantime, localised new hotspots of virus resurgences may not prompt new full-scale lockdowns, yet do pose some risk to a smooth path forward.The combination of the lockdown-induced demand and supply shocks introduced distortions in price dynamics far beyond seasonality, as demand for “essential” goods and services skyrocketed, pushing prices up, while prices of “non-essential” goods and services collapsed. While these distortions are expected to correct, in the meantime they will still add some volatility in inflation data in the months to come, as these adjustments may come with unpredictable timing. For DM, we expect inflation to remain subdued in the near term but to move higher next year due to a combination of a) disappearing negative energy base effects b) the narrowing gap between output and input prices due to cost-push pressures and c) the vanishing base effects of VAT cuts, where implemented. However, this upward trend will stabilise around target, after peaking in mid-2021. In EM, inflation started to pick up in July, mainly driven by supply shocks. Goods and food, in particular, are still playing an important role in CPI baskets. The overall picture is expected to remain benign, bringing headline inflation within CBs’ targets, however, the price dynamics are worth monitoring given the huge dovish efforts put in place by most of the CBs. 
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Credit remains our main conviction in risk assets. Hedging against an uncertain back-to-school phase remains key, in our view, to protecting portfolios. |
Maintain balanced views to avoid extreme positionsAs we progressed through this summer’s earnings season, we saw the pandemic resume in some parts of Europe as well as an escalation in US-China tensions, possibly linked to the upcoming US elections. On the other hand, the news around vaccines, economic data and corporate earnings (better than the very low expectations) drove the markets. While we acknowledge the marginal improvement in economic conditions, we believe, it is not a time to be extremely ebullient. At the same time, it is not advisable to be completely risk-off. Instead, investors should adjust their portfolios to deal with asymmetric risks. Overall, a balanced, defensive and diversified stance is preferred. High conviction ideasIn DM equities, we have become more constructive on Europe over the summer as the region appears to be in a better shape now, with strong growth and lower political risk. However, this should not come at a cost of a lower liquidity focus and investors should constantly monitor liquidity amid the second wave of the virus in the region and prospects of localised lockdowns. Across the atlantic, political tensions in the US, both within the country and with China, seem to be ratcheting up in an election year, leading us to maintain our cautious stance. In addition, US is displaying areas where valuations are extreme historically and they are driving up the entire market. Selected emerging markets have demonstrated a better containment of the contagion. Our regional preference remains for China, Indonesia, South Korea and Taiwan, not least because of the strong stimulus and sector exposure. On duration, we remain close to neutral on US Treasuries as the Fed is likely to keep its ultra-loose monetary policy stance, which will prevent long-term yields from rising too much. In its latest policy minutes, even though the Fed refrained from providing guidance on forward rates and yield curve control, we believe we are already in a curve control environment of sorts. We still prefer the US 5Y vs. the German 5Y bonds, as relative value is even more in favour of the US now due to its safe haven status. However, we are now monitoring the 5-30Y curve which is still driven by sentiment. With respect to US inflation, we maintain our positive view in light of attractive valuations and support from the still nascent recovery. Euro peripheral debt remains attractive amid the collective support from the EU initiative and accordingly we are slightly positive on Spain. Credit is an oasis of income for investors in the yield-starved fixed income world, where we maintain a preference for IG (especially in Europe) over HY, but selectivity is key. In general, valuations in IG are attractive vs HY, particularly US HY, when compared with fundamentals and the continued central bank support. EM debt, where we remain neutral, seems to be the only cheap asset class in terms of spread in fixed income, but requires active selection. In EM FX, we are positive on selective high yielding currencies, given that they will benefit from a risk-on sentiment; however, we remain watchful of any tension around the US-China geopolitical environment or oil price wars. On DM FX, given the low visibility, it is prudent to remain positive on NOK vs EUR as the former could provide an upside if the economic situation improves. Risks and hedging |
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A second wave of Covid-19, limited or no progress on Brexit talks and uncertain US elections all present risks to portfolios. Investors should maintain sufficient hedges in the form of JPY and gold. However, given the already sharp movement in the precious metal, gold prices should be actively monitored. USD options may also serve as a safeguard against downside, as we expect the USD to strengthen in a risk-off environment. 
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Credit and EM debt, particularly high yield, offer the potential to deliver additional yield to investors. However, the focus on quality and liquidity should not be diluted.
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Hunt for income, but stay mindful of pricey areasMarkets are being influenced by the news flow around fiscal and monetary interventions, which continue to drive rates and spreads lower even though governments are scrambling to restore fiscal support in some countries. However, increasing debt levels, the risk of a second wave of the virus and geopolitical tensions in a US election year remain an overhang. From investors’ perspective, while the temptation to move further down the credit quality spectrum for that extra yield remains high, this should be balanced with the need for high selection and a focus on liquidity. Global and European fixed incomeWe refrain from making any strong call on duration, carefully maintaining our close to neutral view overall (positive US, cautious Euro) and are now constructive on China.Our focus is on relative value opportunities, where we are more optimistic on US vs. Germany and towards Australia vs. Canada. Euro peripheral debt remains attractive as political risks subside, although we believe investors should lock-in gains where appropriate. Amid a staggered economic reopening, we are only slightly constructive on inflation, as a spike seems unlikely in near term, but breakeven valuations remain attractive. On yield curves, we now see a higher possibility of curve flattening in the US and Japan and believe steepening is unlikely in core Euro as ECB will limit rate hikes. However, we now believe investors could benefit from UK curve steepening. In a world of lower-for-long rates, credit is one of the few areas where investors can get yield. While remaining positive on credit in the medium term, we think, for tactical reasons, there is need for some caution ahead of heavy issuance in September. We are constructive on financials and subordinated debt. US fixed incomeHigh frequency and real data remain encouraging even as the Fed maintains an easing stance. However, we are seeing a socio-economic divide among classes and between large and small businesses. While we realise a Democrat win could be a headwind for corporate growth, Trump should not be written off completely yet. As a result, our overall stance is of caution, mixed with sufficient liquidity buffers. We remain defensive on USTs (overvalued): increased UST issuance, a pick-up in economic activity and deficit spending are all elements to monitor. The last two are likely to push long- and medium-term inflation upwards. In corporate credit, we are positive but recommend investors to take profits in bonds and loans where valuations are full. A strong housing market, and a resilient, deleveraged consumer, bode well for the consumer and residential mortgage credit markets (attractive valuations). Here, we remain optimistic on non-agency RMBS and believe agency MBS are a good way to gain UST exposure as they provide liquidity. We also like uncorrelated assets, such as ILS and TIPS. EM bondsHard currency debt remains our favoured asset class. In HY, we think there is still ample room for further spread compression, while we view IG as increasingly expensive. We remain positive in EM rates overall, but are selective. FXWe remain constructive on EUR/USD (EU agreement) and positive on JPY/USD but believe GBP could remain weak amid a hard Brexit. In EMs, we are more positive towards Asian FX (first-in, first-out), but neutral on commodity FX and we prefer relative value trades. 
GFI= Global Fixed Income, GEMs/EM FX = Global emerging markets foreign exchange, HY = High yield, IG = Investment grade, EUR = Euro, USD = US dollar, UST = US Treasuries, RMBS = Residential mortgage-backed securities, ABS = Asset-backed securities, HC = Hard currency, LC = Local currency, TIPS = Treasury Inflation Protected Security, ILS = Insurance linked securities, CRE = Commercial real estate, JPY = Japanese yen. |
We are cautious on high growth stocks with extreme valuations, and prefer quality and cyclical names.
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Time of huge contrasts: play market dislocationsOverall assessmentAbundant liquidity lifted equities higher over the summer, supported by Q2 earnings season that turned out to be stronger than depressed market expectations, implying potential for positive earnings revisions. We are seeing an extreme valuation dispersion with significant underlying differences among stocks and sectors (expensive technology names vs materials for instance). The uptrend appears uncertain as current levels seem to fully price-in an economic recovery, and to some extent a vaccine availability. Corporate solvency is another risk as the “whatever it takes” rhetoric has left investors complacent. This, coupled with limited forward guidance, underpins the need for caution with an attention to company balance sheets, extensive scenario analysis and balanced portfolios. European equities
Our focus on stock selection, robust bottom-up discipline and liquidity is evident through our stance towards cyclical luxury and materials sectors, where we reinforced our positive view on construction materials. The latter experiences high barriers to entry, non-disrupted businesses, attractive valuations and has seen strong earnings revisions. It will also be a key beneficiary of the EU Recovery Fund, which could provide additional upside potential. On the other end, we also see prospects for attractive defensive names such as in healthcare. However, we are cautious on consumer discretionary (retail, media, auto) owing to structural weakness, and on technology. Technology offers a very expensive source of structural growth, and has excessive valuations and implied expectations in our view. We also view the current low-rate regime is negative for banks, where return on tangible book value remains weak. US equitiesUS equities continue to offer better value than bonds and this explains investor appetite for this market which is reaching record highs despite the uncertainty around a second wave of Covid-19, the November US elections and tensions with China. Looking at fair valuation for the overall market, we see the tech sector is reaching some extremes and thus requiring caution. We have a balanced view across sectors due to the wide range of outcomes from the Covid-19 and the presidential elections. We are exploring quality names in industrials that are not subject to the challenges of permanently low rates. We also still prefer industrials to financials/energy, and staples/utilities (attractive valuations now) to real estate. In light of the increasing valuation divergence between mega caps and the high growth large caps vs. the rest of the market, we are constructive on high-quality value names. We like stocks with the potential for high returns and balance sheet/secular advantages, and are even willing to look for quality in the lower rungs of the large-cap universe. However, we remain cautious on distressed value and high-growth names. EM equitiesA coronavirus resurgence and unstable US-China relationship are weighing on EM outlook, pushing us to remain cautious. We favour countries in Asia (Korea, China) as they proved to be the first ones to navigate out of the pandemic. We like some inexpensive EMEA countries and/or those with good dividend yield prospects (Russia, Poland). At sector level, we recommend a balance between growth and value areas, with selectivity in discretionary, industrials, materials, tech and IT. 
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