Coffee Break 6/14/2021

LAST WEEK IN A NUTSHELL

  • In the US, consumer prices jumped by 5% year-on-year in May, the fastest pace since the summer of 2008. Surprisingly, at first sight, bond yields fell, with last month’s figure representing what could be a local peak.
  • Unsurprisingly, the ECB was not unanimous in deciding to maintain an elevated flow of stimulus, and Christine Lagarde carefully avoided “taper talks”, as inflation was going to remain below its 2% target.
  • The US Senate passed a bill giving the government $250bn to spend on R&D in new technologies in order to counter China’s increasingly competitive threat.
  • G7 nations agreed to set a 15% minimum global corporate tax rate.

 

WHAT’S NEXT?

  • It will be a very important week for markets, as the FOMC could open the discussion regarding the "tapering" of asset purchases, new dot plots will be published and Chair Powell is expected to comment on inflation.
  • Following the G7 summit, geopolitics will remain in the spotlight with a NATO summit, an EU-US summit in Brussels and a meeting between Joe Biden and Vladimir Putin in Geneva.
  • China will drive the focus, as the NDRC has vowed to control corn, wheat and pork prices after the significant 9% PPI surge in May. Separately, US-China relations should remain on edge, with the US Administration set to launch new trade talks with Taiwan. 
  • On the data front, investors will focus on retail sales, industrial production and PPI inflation in the US, CPI inflation across the euro zone and the UK, and industrial production and retail sales in China.

INVESTMENT CONVICTIONS

  • Core scenario
    • The economic recovery should continue over the next year with continued fiscal support and prudent central banks which will be careful in communicating a gradual removal of monetary accommodation. For the time being, the pandemic seems manageable, as the virus mutations are being addressed by the vaccines.
    • We believe that this context is positive for equities vs bonds. In the same way, the sequential current equity rotation may continue, helping ex-US equities to benefit from new inflows.
    • In the US, more spending and more taxes are expected. The latter could support higher yields, while a coming tapering should be announced in the coming months.
    • In Europe, our central scenario assumes a comeback to growth trend by end-2021 and an implementation of the Next Generation EU plan in H2. Economic indicators still reveal a large gap to be filled between services and manufacturing, with the latter already starting to incorporate the global economic rebound. Hence the reflation trade could well move into a next stage as external demand surges and domestic demand recovers.
  • Market views
    • Investors’ sentiment, positioning and volatility are recovering from crisis levels but are not complacent or extreme.
    • Markets have well integrated the stage of the strong “mechanical” rebound after the pandemic, as evidenced by the strong outperformance of cyclicals. We may now expect positive but lower returns.
    • We note that speculative assets have corrected without destabilising stocks and the market is now on a slightly healthier path.
    • Central bank communications and the pace of nominal rate increases will determine the performance and volatility of the financial markets in the next phase.
    • We are sticking to our positioning that favours non-US equities and we keep hedges against higher yields and inflation; we are also keeping European and US banks, US and European small and mid-caps, and exposure to commodities, GBP and NOK.
    • Simultaneously, our core portfolio keeps the most resilient themes and countries.
  • Risks
    • Uncontrolled rise in bond yields. Some US indicators are already pointing to a stronger labour market. Should this materialise in the upcoming employment reports, we may see higher yields, both real and nominal.
    • Supply-side constraints: Corporates have warned about the difficulties they are having hiring and also building their inventories to meet the rebound in demand. If this takes too long, such a context could bring more price rises without higher growth, putting margins under pressure.
    • The virus vs vaccine duel. The mutating coronavirus should become endemic, as immunity is not steady and therefore needs a constant and full commitment to the vaccination campaign.
    • Geopolitical tensions. Revived tensions between China, and/or Russia, and the US are on the agenda, as witnessed by the G7 and NATO summits.
    • Political uncertainty: The social divide is widening between losers and winners of the health crisis and several countries have elections coming up in the next 12 months starting with Germany which will elect a new Parliament in September.


RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

The global context remains in risk-on mode, with supportive economic data and improving growth expectations fuelling sentiment. However, some major risks remain, be they political, geopolitical, or policy-related. We are now living with the virus and, while vaccination discrepancies will persist, economic volatility and negative market risk should gradually abate. While inflation fears are growing, we believe the current rise should remain temporary, i.e., settle down somewhat over the coming quarters.
In that context, we remain underweight government bonds and are maintaining a short duration in the euro zone and the US. On the equity side, we remain overall overweight equities and our strategy is geared towards reflation trades and long-term winning sectors. Despite an already strong catch-up, we also continue to see some upside on commodity prices. Given the risks described here, we are keeping some derivative protections.

 

CROSS ASSET STRATEGY

  • The economic recovery is expected to be sustained over the next year with continued fiscal support and prudent central banks. We continue to prefer equities over bonds in this context.
    • On the equity side, the impact of the pandemic is set to diminish and, as countries emerge from the crisis, their economies should rebound and rebuild. The COVID crisis may have little effect on the long-term growth potential of economies and is even pushing for accelerated productivity gains. Rebuilding after the pandemic implies that growth will perhaps be different, with less globalisation and more green and equitable growth, but it could also mean margin pressure for some companies. Hence our strategy is geared towards reflation trades and long-term winning sectors. Our multi-asset investments can be summarized as follows:
      1. We have exposure to assets related to the post-COVID rebound/recovery
        Underweight government bonds, keeping a short duration. We focus on the source of the highest carry, i.e. emerging debt. We stay neutral US and European investment grade credit.
        We have an exposure to rising commodity prices, via a basket that includes currencies, such as the AUD, the CAD and the NOK and we remain long GBP.
      1. Positive stance on Small caps
        Current context is still supportive for ongoing rotation towards stocks geared to the recovery, a steepening of the yield curve and rising commodity prices.
        We are buying small and mid-caps in the US, the UK and Latin America.
      1. Positive stance on Global Banks
        In spite of a sharp rebound in the past months, Banks in the euro zone still present a steep discount to their long term average and we are adding EMU banks. We also keep an overweight stance on US banks, which could benefit from the yield curve steepening: We expect US10Y yields to hit 2% in the next 12 months.
      1. Positive stance on long term growth thematics
        Inclusion of secular megatrends to profit from long-term sustainable growth. The pandemic revealed that they are helpful in building a resilient portfolio. Environmental solutions, digitization and healthcare are our strongest thematic convictions.
        Oncology and Biotech sectors reveal high growth potential.
        Keep exposure to Tech and Innovation themes.
        Purchase of consumer staples names (Food & Beverage sector). 

Our positioning