Coffee Break 7/27/2020

INVESTMENT CONVICTIONS

• Core scenario
  • Our central scenario forecasts a gradual recovery of financial markets, mainly thanks to abundant liquidity and government support. In the coming months, markets should nevertheless continue to trade in a wide and choppy range. The contradiction between the strength of the financial market and the cautiousness of investors persists.
  • The European policy response has given some reassurance: policymakers have successfully addressed several flaws in the past weeks 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”.
  • Our main convictions are twofold:
    • First, stay with the medium-term “winners” of the crisis, such as Technology, Healthcare, Sustainable themes.
    • Second, add positions in assets at historically attractive valuation levels, as it provides investment opportunities. We have identified Banks among value sectors, Emerging market debt and cheap currencies. We have also increased some regional accents (Europe and Emerging Markets -especially Chinese A-shares- vs. US and Japan).

• Market views
  • The rate of contagion is falling in spite of re-opening in many countries. In the US, however, the trend is a concern: the US have not been able to curb the virus infections to the low levels seen in Asia and continental Europe.
  • 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.
  • Volatility is here to stay as visibility on the epidemic and its aftermath remains low, notably in the US, where the election campaign is heating up. Also, US-China relations are increasingly tense.
  • From a short-term perspective, some reassurance can be found in the bottoming and steadily ongoing recovery of economic indicators, the rise in economic surprises and stabilising earnings revisions.
  • From a longer-term perspective, H2 earnings will matter and determine the shape of the recovery. A V-shaped recovery seems to be the most likely one with a more inclined second leg. The market does not seem to take into account the possibility of a second crisis or even stagnation.

• Risks
  • The coronavirus pandemic is a risk until it is contained or a vaccine is found, successfully tested, mass-produced and commercialised. Local outbreaks are likely, a second wave is possible but a worldwide generalised shutdown is unlikely.
  • US election risk. The handling of the coronavirus crisis, economic strains, social unrest and a potential fiscal stimulus cliff at the end of July are triggering uncertainty at a time when valuation is no longer appealing vs. historical levels. A Democratic sweep on election day could represent a risk for the stockmarket due to a possible tax reform and increased regulation.
  • The US-China relations will likely remain on edge and are clouding global growth. Neither country can afford a revival of a trade war.
  • Trade negotiations between the UK and the EU. EU negotiator Michel Barnier expects the “moment of truth” for any potential trade deal in October. A “thin” free trade agreement is a realistic assumption.

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

We remain overall underweight equities, keeping some protection on equities via options. We also maintain gold and JPY as portfolio hedges. That being said, we have deep convictions in the structural reduction of the euro zone risk premium. It translates into an overweight EMU equity vs US equities. We are neutral UK equities after a recent upgrade from underweight as the country offers opportunities as it should benefit from better economic data, government fiscal support and a better control of the epidemic. We are overweight emerging markets equities (via Chinese A shares) vs. an underweight Japanese equities. Finally, we keep an exposure to emerging debt and investment grade bonds.

CROSS ASSET STRATEGY

• Our equity exposure is slightly underweight, but with an increased selectivity in regional equity allocation.
  • We have an overweight euro zone vs. an underweight US equities. The coordinated reponse of member states to the virus has strengthened ties while valuation still offers a relative discount vs the US and positioning is just starting to pick up. Usually, a recession-resilient country, the US now appear more fragmented than Europe. Besides the electoral uncertainty, valuations are no longer attractive vs. historical levels. Also, buybacks, an important driver in the past 5 years, should be much lower.
  • We are opportunistically neutral UK equities, after a recent upgrade from underweight. There is potential in a short-term catch-up by UK equities after a disappointing month of June. The strong underperformance in the rebound shows a disconnect between the index and the state of the economy.
  • We are overweight emerging markets equities (via Chinese A shares) and have yet again increased our exposure vs the broad emerging market. And we remain underweight Japanese equities. China is rapidly recovering from the coronavirus crisis while Japan is likely to suffer from declining profit forecasts.
  • 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 and circular economy themes enable exposure to key solutions for a cleaner future. We 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 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, with a preference for hard currency and ESG.
  • We have an exposure to the NOK, which appeared attractive during the crisis, as well as gold and the JPY, which are risk mitigators.