Coffee Break 30/03/2020

LAST WEEK IN A NUTSHELL

  • The Covid-19 epidemic is rapidly spreading through Europe and the US. It is slowing in Italy but worsening in Spain and especially in the US where several epicentres have been declared.
  • Financial markets are digesting the negative data, including the skyrocketing jobless claims in the US with more than 3M filing for unemployment benefits and the weak flash PMI.
  • The US government succeeded in bringing some relief by agreeing on a stimulus package.
  • In a live television interview the Chairman of the Federal Reserve said that the US may well be heading into a recession but there is nothing fundamentally wrong with the economy except for a virus that needs to be contained ASAP.
  • In the euro zone, the German parliament approved a stimulus programme of EUR 750bn, and the ECB decided that the self-imposed issue-limits “should not apply” to its new PEPP, sending the euro higher.

 

WHAT’S NEXT?

  • Global services and composite PMI’s will be published and should confirm what flash PMI’s anticipated: a sharp deterioration in soft data.
  • The US will publish the job report for March, a week after jobless claims skyrocketed to more than 3 millions.
  • The euro zone will publish the final figures for consumer and business confidence data and in Japan, the Q1 Tankan survey will be published.
  • Unless there are further emergency moves, central banks will take a back seat with no major meetings scheduled and speaker events called off.

INVESTMENT CONVICTIONS

  • Core scenario
    • We are watching 5 different triggers: Epidemic-linked indicators, Market risk, Activity resumption, the Policy response and Valuations. Noteworthy is that the epidemic-linked indicators are the highest in the US and that activity resumption is the farthest ahead in China as it is almost back to “normal” levels.
    • Currently, the measures that will minimize the human cost of the outbreak are likely to maximize the economic cost. Hence, in the short term, economic growth will contract.
    • In the medium term, policy easing from virtually all central banks and upcoming fiscal easing represent a support. The Fed, the ECB and the BoJ have already eased policies further, they are ready to take additional easing measures as needed and are encouraging fiscal stimulus.
    • The spreading of this virus has a seldom-before-seen impact on volatility and financial markets: equity, bonds, forex and commodities alike. The coronavirus’ impact is challenging to assess as new cases are declared and increasing in various countries.
    • Negative economic news flow is already integrated to a great extent in todays’ market prices, but with a fat tail risk.
  • Market views
    • Since the onset of the covid-19 crisis, we are looking at the depth (deep), diffusion (global) and the duration (temporary) to assess the economic pain of the coronavirus. This is challenging to assess as the whole international value chain is impacted.
    • Policy response will outlive the virus. In the euro zone, the ECB announced a EUR750bn Pandemic Emergency Purchase Programme (PEPP). This PEPP will involve purchases of private and public securities and include all assets eligible under the current asset purchase programme, without self-imposed issue-limits.
    • In the euro zone, the activation of the European Stability Mechanism (ESM) to deal with the impact of the coronavirus via joint issues is being discussed.
    • In the US, economic relief is gaining traction and could reach levels north of USD2tn.
    • In the corporate sector, we expect downward revisions in earnings and cuts in dividends.
  • Risks
    • In the short term: the coronavirus is a risk until it is contained or a vaccine is found, successfully tested, mass-produced and commercialised.
    • In the medium term:
      • Domestic political issues in the US. The electoral campaign is ongoing. The candidate to go against incumbent president Donald Trump on election day has yet to be nominated. The Democratic National Committee had planned for an April debate but has yet to announce a specific date or a media sponsor.
      • Trade negotiations between the UK and the EU. The UK left the EU on 31 January 2020 and has barely started negotiations to reach a trade deal by the end of this year. EU's chief negotiator Michel Barnier had tested postive for COVID-19 as did UK Prime minister Boris Johnson.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

Our objective stays simple: gear the strategy towards a neutral equity positioning in the next weeks. We sold our derivative protections. We remain neutral on our regional allocations. Government bonds spiked as they temporarily benefited from the global risk aversion. Nevertheless, we remain cautious about exposure to government rates in Europe as central bank buying and deterioration in public finances will be huge. Credit and High Yield spreads have spiked but our strategic views have not changed. We stay diversified via alternative strategies. Our stance on Emerging debt has become cautious and opportunistic. We continue to hedge via the JPY, among others.

 

CROSS ASSET STRATEGY

  • We are adapting our outlook on equities: we are closing the gap of our underweight in order to become neutral equities within the next weeks.

    • We are in the process of becoming neutral European equities and no longer hold derivative protections. This fast market reaction can create upsides on equities even if the impact of the coronavirus will linger.
    • We are neutral Emerging market and Japanese equities. Uncertainty surrounding the coronavirus weighs on investors’ sentiment.
    • We are neutral US equities. Similarly to other equities markets, the valuation of the US market has dropped by more than 25% but it has rebounded sharply in the past days.
    • We keep key convictions in various thematic investments. Oncology and Biotech sectors reveal high growth potential driven by innovation and pricing power. Climate action themes enables exposure to key solutions for a cleaner future.

    We are underweight bonds, keeping a short duration and diversify out of government bonds. The current environment has the potential to create opportunities on bond markets as well.

    • We expect bond yields to stay low but creep up gradually over the medium-term. .
    • We diversify out of low-yielding government bonds. In credit, our preference goes to Emerging debt, including EM-issued corporate bonds. We note that US High Yield rate jumped to over 9.3% while the Euro High Yield rate has now a yield of 7.7%.
    • We keep an exposure to gold and JPY, which both play the role of safe haven.