Coffee Break 26/07/2021

LAST WEEK IN A NUTSHELL

  • The ECB held its monetary policy and shifted in the direction of “accommodation for longer” with a higher threshold required for tightening. The ECB suggested that any tightening would occur when:
    • Inflation would reach 2% “well ahead of the end of its projection horizon”;
    • When it would judge that “realised progress in underlying inflation is sufficiently advanced”.
  • OPEC and its allies stroke a deal to raise oil production to gradually restore capacity cut at the start of the pandemic.
  • US jobless claims rose to 419k last week, higher than consensus expectations (350k). The rise was mainly driven by auto manufacturing. Problems with seasonal adjustments given the pandemic may also account for some of this surprising figure.
  • Euro Flash Composite PMI climbed to 60.6 in July from 59.5, its highest reading since July 2000 as loosening of more COVID-19 restrictions gave a boost to services.

 

WHAT’S NEXT?

  • Fears of another wave of infections might grow and hit business confidence as the delta variant has globally risen from 10% to 90% of cases in 6 weeks.
  • US Deputy Secretary of State Wendy Sherman will visit China to meet Chinese Foreign Minister Wang Yi, setting the stage for a potential meeting between Joe Biden and Xi Jinping later this year.
  • The FOMC meeting should be the highlight of this week.
  • Summer Olympics in Tokyo will see their first week of competition with rising fears that the spread of the variant will interfere with the smooth running of the event.
  • Google, Apple, Amazon and Facebook will release the same day their earnings reports (July 30th).

INVESTMENT CONVICTIONS

  • Core scenario
    • The economic recovery should continue in 2022 with continued fiscal support and prudent central banks. Developed countries have peaked on the pace of vaccination, economic indicators, liquidity, fiscal support and are entering the transition phase to still strong but more differentiated economic growth.
    • The risk reward seems less attractive for the next few weeks until a clearer and more positive direction is found. The delta variant may pose a risk to growth.
    • We believe that this context remains positive for ex-US equities, value stocks and assets (banks, commodities) to hedge inflation and higher yields.
    • In the US, more spending and more taxes are expected. The former 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 gap to be filled between services and manufacturing, with the latter starting to incorporate the global economic rebound. However, current valuation looks expensive especially for small caps vs large caps.
  • Market views
    • Central bank communications and the pace of nominal rate increases will determine the performance and volatility of the financial markets in the next phase.
    • 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.
    • Investors’ sentiment and positioning have recovered from crisis levels and recent Fed-induced volatility but are not yet complacent or extreme.
    • We are sticking to our positioning that favours non-US equities and we keep hedges against higher yields and inflation. We are buying European and US banks, US small and mid-caps, and have an exposure to NOK.
    • Simultaneously, our core portfolio keeps the most resilient themes and countries.
  • Risks
    • The virus vs vaccine duel. A resurgence of infections due to the delta variant underlines the risk of economic restrictions lasting longer than initially expected. The mutating coronavirus should become endemic, as immunity is not steady and therefore needs a constant and full commitment to the vaccination campaign.
    • 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.
    • Geopolitical tensions. 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

After a first quarter buoyed by hopes of an end to the health crisis, positive equity performance, negative bond performance and strong outperformance of value and cyclicals, investors showed less conviction in the second quarter. US interest rates peaked on March 30th, and both equities and bonds posted positive returns in Q2 in much lower volumes.
According to our historical observations, we can now expect positives returns, but at a lower level, with much higher sensitivity to bond yields’ evolution and stretcher valuations of risky assets. Ahead of summer, we expect a more sideways phase and a possible increase in volatility before finding a clearer direction and a continuation of the reflationary environment. In this context, we decided to take profit on our European tilt. We are now neutral Europe and thus neutral equities. More recently, we took partial profit on commodities as OPEC+ has reached a deal to increase production while uncertainties about the spread of variants could negatively impact demand in the short term.
We are keeping hedges against higher yields and inflation and some derivative protections. We have identified various possible catalysts (delta variant, supply-side constraints, etc.) for an equity market correction from which we might take advantage of during the summer.

 

CROSS ASSET STRATEGY

  • We expect a more sideways phase with a possible increase in volatility before finding a clearer direction and a continuation of the reflationary environment. We are neutral equities and underweight bonds.
    • 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
        Neutral equities, underweight bonds, preference for ex-US equities.
        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 currency exposure through the NOK.
      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 have a position on small and mid-caps in the US and Latin America, and decided to take profit on our UK exposure.
      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 US 10Y 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 in the European Food & Beverage sector.

Our positioning