Coffee Break 6/22/2020

INVESTMENT CONVICTIONS

• Core scenario
  • Recent market performance has revealed two messages: First, stay with the medium-term “winners” of the crisis (e.g. Technology, Healthcare, Sustainable themes) and, second, enter positions in assets at historically attractive valuation levels, also providing investment opportunities (we have identified Emerging market debt, value sectors, cheap currencies and are now adding to euro zone equities relative to US ones).
  • We are watching various epidemic indicators to assess our stance and conclude for now that the rate of contagion is falling in spite of re-opening. Most countries managed to successfully control the virus progression. In the US, however, the trend is a concern. The country has not been able to curb the virus infection to the low levels that would help prevent a second wave. We note that, in spite of rising infections, the fatality rate in the US continues to fall.
  • In the medium term, policy easing from virtually all central banks and fiscal easing represent a support. The Fed, the ECB, the BoE and the BoJ keep on easing policies further.
  • From a short-term perspective, some reassurance can be found in the bottoming of economic figures and the rise in economic surprises. Volatility is nevertheless here to stay as visibility on the aftermath of the epidemic remains low.

• Market views
  • Most countries have reached their peak in terms of active Covid-19 cases. The epicentre has now moved to South America.
  • Mobility indicators continue to improve fast and there is an overdispersion in Covid-19 transmission and the effective reproduction number could be drastically reduced by preventing relatively rare superspreading events.
  • Fiscal and monetary policy responses will outlive the virus. Monetary policy responses aim at ensuring ample liquidity and, for some regions, further asset purchases programmes.
  • The European political response has given some reassurance: policymakers have addressed several flaws in the past weeks successfully which could result in a decline in euro zone equities’ risk premium. The past weeks could be seen as the fiscal equivalent to the monetary “Whatever it takes”.

• Risks
  • The coronavirus is a risk until it is contained or a vaccine is found, successfully tested, mass-produced and commercialised. A second generalised shutdown is however unlikely.
  • US election risk. The handling of the coronavirus crisis, upcoming presidential elections and social unrest are triggering uncertainty at a time when valuation is no longer appealing vs. historical levels. A Democratic sweep could represent a risk for the stockmarket (tax policy, healthcare regulation).
  • The US-China relations will likely remain on edge and are clouding global growth.
  • Trade negotiations between the UK and the EU. The UK made clear that the withdrawal would not be delayed beyond 31 December 2020. A ‘thin’ free trade agreement is a realistic assumption.

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We are underweight equities while keeping a pro-risk exposure within our portfolio (“Barbell strategy”). We express our pro-risk stance via a bias towards value sectors, including banks (but we took profit on the automobile sector), holding emerging markets debt (in both LC and HC) and European corporate bonds, as well as having a currency exposure towards the NOK. In addition to our underweight equity stance, we hold a protective derivative strategy, gold and JPY as risk mitigators. The market has become more vulnerable to disappointments. Now, we are increasing our equity exposure to EMU while decreasing the US, based on a strong and coordinated policy response, better virus control, relative cheapness and light positioning.

CROSS ASSET STRATEGY

• Our equity exposure is slightly underweight, while increasing the exposure towards a lower euro zone risk premium.
  • We have become overweight EMU equities vs. US. Policymakers have successfully addressed several flaws in the past weeks which could result in a decline in EMU equities’ risk premium.
  • We have become underweight US equities. The handling of the coronavirus crisis, upcoming presidential elections and social unrest are triggering uncertainty at a time when valuation is not so appealing vs. historical levels.
  • We stay slightly underweight UK. Covid-19 has changed priorities in the UK. There is rising concern about a no-deal end to the transition period for the UK’s exit from the EU. A ‘thin’ free trade agreement (incorporating zero-tariff/zero-quota trade in goods, but significant non-tariff barriers on trade in services) to be struck by the end of the year is a realistic assumption. A no-deal end to the transition (or just rising uncertainty around any deal or lack thereof) would hit foremost UK domestic stocks.
  • We stay neutral Japanese and Emerging markets equities. Uncertainty surrounding the aftermath of the coronavirus crisis weighs on investors’ sentiment. On the other hand, the fiscal and monetary responses are massive.
  • Since the onset of the coronavirus crisis, some assets have been badly hit and now offer historically attractive valuation levels, providing investment opportunities. While it is not easy to find the best entry point, it makes sense to strengthen some positions opportunistically. For instance “value” sectors such as European banks are already integrating a lot of bad news.
  • We keep key convictions in various thematic investments. Technology, Oncology and Biotech sectors prove relatively resilient in the current context and reveal high growth potential driven by innovation and pricing power. Climate action themes enable exposure to key solutions for a cleaner future. We also believe that sustainability will continue to gain in importance for the social and environmental aspects. A robust governance appears to deliver better results during the pandemic, both at company and state level.
• We are underweight bonds, keeping a short duration, but highly diversified as the current environment has the potential to create opportunities on bond markets.
  • We are underweight government bonds which provide no return potential except in risk-off phases and their accompanying flight to quality. We prefer peripheral bonds vs. core European countries.
  • In a multi-asset portfolio, diversification into credit appears more attractive. We are overweight US and EUR investment grade as central banks buying represent a support.
  • We are also overweight Emerging debt, including corporate bonds, in both local and hard currency.
  • We have an exposure to the NOK, which appeared attractive during the crisis, as well as gold and the JPY which are risk mitigators.