House View, September 2020
A surge in new covid-19 cases in a number of countries has interrupted progress towards normality, yet the effects of the virus are becoming more manageable and positive world H2 growth is achievable.
Prospects for the US economy hinge on the ability of Washington to agree a new fiscal support package. While we have raised out 2020 GDP projection for the US we remain prudent. We expect the Fed to provide more stimulus via increased asset purchases, possibly as early as this month.
Spikes in covid-19 cases in Europe have hit tourism hard, particularly tourism-dependent southern countries. China leads in terms of a return to normality but tensions with the US continue to rise. A continuance of Abenomics is expected in spite of the resignation of prime minister Shinzo Abe as the Japanese economy recovers from a record contraction.
The dollar remains in a cyclical down phase attributable to the sharp decline in US real rates, the effects of covid-19 and reduced safe-haven demand. But we believe that recent weakening has been a bit stretched on a fundamental basis. Consequently, we see little immediate upside in EUR/USD rates.
Private assets will continue to offer superior average annual returns in the decade ahead in exchange for a certain illiquidity. Attractive avenues include co-investments and ‘thematic investing’ in private equity. In private real estate, along with value creation, income generation from core investments is becoming of greater importance in an era of ultra-low bond yields.
While a global economic recovery is underway, we may need to wait until Q4 to be sure that momentum is being maintained. The concentration of market performance in a limited number of technology and healthcare stocks is feeding uncertainty, compounded by continued China-US tensions. Consequently, we remain underweight equities, while favouring themes such as structural growers. Rising volatility can be exploited across asset classes.
With inflation expectations rising in the US following the Fed’s commitment to ‘flexible inflation targeting’, lack of consensus in the inflation/ deflation debate will provide opportunities that require active management and diversification. We continue to favour gold and, while tactically cautious on the euro, we are positive on defensive currencies such as the Japanese yen and Swiss franc against the dollar.
While Q2 earnings were the second worst ever, they proved better than expected. US tech stock valuations appear stretched as the US elections loom into view. A Biden presidency could hurt the earnings recovery pencilled in for US corporations in 2021. We have therefore decided to downgrade our US equity allocation to underweight from neutral while keeping a neutral stance on DM equities generally.
While underweight global EM, we are positive on northern Asia on the grounds of superior economic and earnings dynamics, a restrained response from China to US pressure, progress on covid-19 and a favourable sectoral mix.
Some cyclical sectors staged a comeback in August, with strengthening demand helping consumer discretionary and industrials as well as US housing. We still await confirmation that the cheapest sectors can catch up on the performance of growth, often tech-related, sectors.
The EU’s new powers to issue debt could result in a pool of bonds worth over EUR900bn by 2024 and marks a significant step towards fiscal union. EU bonds will share many of German bonds’ traditional ‘safe haven’ characteristics.
The US plans to issue a net USD5,388bn in debt in 2020. The prospect of increased supply placed upward pressure on US yields in August. The Fed could increase its purchases of long-term US Treasuries although we do not expect it to implement explicit Japanese-style yield curve control this year.
We remain neutral EM local-currency sovereign bonds as yields are unlikely to move much lower, but we are looking closely at Chinese sovereigns, which combine relatively attractive yields considering China’s credit rating and limited currency risk.