Coffee Break 3/23/2020

LAST WEEK IN A NUTSHELL

  • Financial markets remained volatile and found some reassurance in central banks’ measures and government announcements. Deteriorating soft data and published profit warnings were no surprise.
  • While announcing a EUR750bn ceiling for its Pandemic Emergency Purchase Programme (PEPP), there is effectively no limit to the ECB’s actions.
  • After falling more than 35% in a couple of days, oil prices registered Thursday their biggest-ever one-day rebound (+24% on WTI).
  • It appears that the epidemic has peaked mid-February in China, but is still gaining momentum in Europe and in the US.

 

WHAT’S NEXT?

  • We maintain the idea the pandemic will result in a deep, but temporary shock. The massive fiscal policy response will probably stay longer than the virus.
  • Europe and the US are bracing themselves for the spreading of the coronavirus and implement drastic measures of social distancing.
  • Data on preliminary global PMIs, business and consumer sentiment and initial US jobless claims will be published. Although a serious deterioration is expected, financial markets might already have integrated parts of it.
  • The Bank of England will meet. Like others, the BoE has already made a series of moves, including emergency rates cuts, an announcement of asset purchases and measures to support the economy.

INVESTMENT CONVICTIONS

  • Core scenario
    • We are watching 5 different triggers: Epidemic-linked indicators, Market risk, Activity resumption, the Policy response and Valuations.
    • 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
    • The depth, diffusion and duration of the coronavirus are challenging to assess as the whole international value chain is impacted.
    • Policy response will stay longer than 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.
    • 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 USD1.2tn in the US alone. Upcoming measures might include helicopter money – sending a check of USD1000 directly to families.
    • The next hurdle will be in the publication of Q1 data on a myriad of indicators to gauge the fallout.
    • In the corporate sector, this will be followed by downward revisions in earnings and cuts in dividends.
  • Risks
    • In the short term: the coronavirus is a risk until it is contained.
    • 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. Odds are increasingly in favour of Joe Biden over Bernie Sanders.
      • 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 while the U.K.'s chief negotiator David Frost is self-isolating after showing mild symptoms of COVID-19.

 

RECENT ACTIONS IN THE ASSET ALLOCATION STRATEGY

This week, our objective has become to gear the strategy from a slightly underweight equities towards a neutral equities positioning in the next weeks by gradually selling some of 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 will be huge. Credit and high yield spreads have spiked but our strategic views have not changed yet. We stay diversified via alternative strategies. Our stance on Emerging debt has become cautious and opportunistic. We continue to hedge via 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 still hold small derivative protection. 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% and is below its historical median (14.7 vs. 16.2).
    • We have 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 very 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 9.8% while the Euro high yield rate has now a yield of 8.4%.
    • We keep an exposure to gold and JPY, which both play the role of safe haven.