Coffee Break 7/5/2021

LAST WEEK IN A NUTSHELL

  • The US published a strong job report for the month of June compared to market expectations. The US economy created 850k new jobs while the unemployment rate edged up to 5.9% and hourly earnings increased by 0.3%.
  • China marked the 100th year of the Communist Party. President Xi Jinping reiterated his will to resolve “the Taiwan question” and maintained an "unshakeable commitment" to unification.
  • Eurozone underwent a temporary dip in inflation, easing by 0.1pp to 1.9% yoy in June. Core inflation was also down, declining 0.1pp to 0.9% yoy.
  • “Sausage wars" is in abeyance after the EU extended the grace period on exports of chilled meat from the British mainland to Northern Ireland until the end of September.

 

WHAT’S NEXT?

  • The job report for the month of June will continue to be digested by investors as the actual number came out much higher than initially expected.
  • Finance Ministers will gather for G20, with hopes from Treasury Secretary Janet Yellen that participants will approve the proposal to adopt a global minimum corporate tax.
  • The Fed will release its minutes after Christopher Waller said it was appropriate to think about pulling back some stimulus and Robert Kaplan continued to promote his view that tapering should start sooner rather than later.
  • The ECB will discuss the strategy review and PEPP. The doves want to link strategy review, the new inflation target and the crisis response, while the hawks want to keep things minimal and separate.

INVESTMENT CONVICTIONS

  • Core scenario
    • The economic recovery should continue over the next year with continued fiscal support and prudent central banks which should be careful in communicating a gradual removal of monetary accommodation. For the time being, the pandemic seems manageable, as the virus mutations are being addressed by the vaccines.
    • We believe that this context is positive for equities vs bonds. In the same way, the sequential current equity rotation may continue, helping ex-US equities to benefit from new inflows.
    • In the US, more spending and more taxes are expected. The latter 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. Hence the reflation trade could well move into a next stage where external demand surges and domestic demand recovers.
  • 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 commodities, GBP and NOK.
    • Simultaneously, our core portfolio keeps the most resilient themes and countries.
  • Risks
    • 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.
    • 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.
    • 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

The global context remains supportive as economic data and improving growth and profit expectations fuel sentiment. Simultaneously, inflation fears have been growing but we believe that the current rise should remain temporary, i.e., settle down somewhat over the coming quarters. We note that some major risks remain, be they (geo)political, policy-related or linked to the pandemic. Markets have well integrated the strong rebound post-COVID: We can now expect positive but lower returns. We are now living with the virus and vaccination discrepancies will likely persist.
In that context, we remain underweight government bonds and are maintaining a short duration in the euro zone and the US. On the equity side, we remain overall overweight equities and stick to our positioning in favour of non-US equities. In the wake of rising equity markets, we recently took profit on our small and mid-cap exposure in the UK. Our strategy is geared towards further progress in the economy and long-term winning sectors. Given the risks described here, we are keeping hedges against higher yields and inflation and some derivative protections.

 

CROSS ASSET STRATEGY

  • The economic recovery is expected to be sustained over the next year with continued fiscal support and prudent central banks. We continue to prefer equities over bonds in this context.
    • 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
        Overweight equities
        vs. 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 basket that includes currencies, such as the AUD, the CAD and the NOK. We recently took profit on our long GBP stance.
      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 are buying 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 benefit from successful stress test results and will increase dividend payouts and buybacks.
      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