Monthly investment review
New economic cycle, with more volatile inflation. Slowbalisation
Liquidity profusion will continue. Pandemics will affect long-term potential growth in G7, through the low marginal productivity of new debt.
Resumption of intense liquidity injections by the Fed
Fed will compensate for the lack of fiscal stimulus in Q4 (political gridlock). Funds’ redirection by the Treasury is anecdotal ahead of Yellen arrival. New Monetary Theory lurks on the horizon.
Growth: temporary relapse. More uncertain U-shape pattern
With selective lockdowns, growth will clearly recede up to Q221. A strong global cyclical recovery should develop from next Spring.
G-Zero world, with clear waning of US election risks. Multilateralism and climate action in the waiting room
A Biden President should gradually rebuild multilateral links .
Vibrant (complacent?) capital flows from money market and gold to risky assets
End of fiscal quarter in the US plus elections perspectives favored risk taking.
Quality assets will remain scarce and expensive
Financial repression will maintain yields low. The pool of income generating sovereign bonds will remain artificially tight. Strong institutional demand for high quality assets will continue.
Resurgence of vibrant appetite for risks, signs of complacency
(Very) strong consensus for weak USD, and reflation trades has emerged…
A pretty smooth phasing-out, finally – As always, the (US) elections were full of surprises. Fortunately, the many disaster scenarios put together by the self-righteous / sensationalist media did not happen. Very little violence, a record turnout, a very clear popular vote. The pathetic gesticulations of Trump’s army of lawyers are part of the reality show – ¨a hype version ¨ – in the pure American style. The markets do not care: the electoral risk premium already evaporated on the eve of the elections, judging by the massive repurchases of risky assets – via ETFs – from the end of October.
The results – which are now almost final – are nevertheless very important. The Democrats did not win all over and the famous ¨blue wave¨ will not take place, we are moving towards cohabitation. The mega-plans evoked during the campaign, Green Deal and Infrastructure, which could have boosted the American GDP to 5% over the next two / three years will have to be revised downwards. Not only Democrats are at risks of not winning the Senate next January. But, surprisingly, they are also in a relatively weak position at the House of Representatives. Hopefully for Biden, the looming tensions between the party left-wing and centrists will not re-emerge…
At the other pole of the political spectrum, it is hard to see the Republicans – freed for the most centrist from the embarrassing tutelage of Trump – systematically obstructing. The mid-term elections are for 2022… In short, US Congressmen are likely to agree to launch stimulus plans that will allow the GDP to grow at 3-4%, a rate above the long-term potential. This is not bad news in the end, as it will avoid the abysmal slippage of deficits and a possible – premature – return of inflationary irritation due to bottlenecks in manufacturing chains, transportation, logistics, etc.
Asset allocation conclusion – Liquidity profusion will continue, even more so in the context of cohabitation, which will probably feature less impulsion – in the US – from the fiscal side. This will spell a weak USD and low policy / short-term rates environment. Reflation trades will continue to develop in the wake of good news on vaccines, featuring the perspective of a new business cycle. As a corollary, lots of institutions / fund managers reinvested their liquidities parked in cash / hedges (like gold) into equities and high yield. This is probably a solid trend, which will perdure in 2021, providing support to financial markets. But considering the high speed and recent strength of the rebound linked to the theme ¨of re-opening¨, more defensive ¨Covid-proof – stay at home¨ type of assets should rebound in the short-term.
Yellen as US Treasury Secretary is USD bearish
Biden is set to nominate former Fed Chair Yellen as the next Secretary of Treasury. She was the odds-on favorite, but this news still carries considerable weight. Yellen was a dovish continuation of the Bernanke Fed. She moved decisively against higher rates expectations when the USD strongly strengthened in 2016. In her economist past, she addressed the dangers of inequality, suggesting as Treasury Secretary she will address employment and labor issues far more aggressively than her predecessor. We are witnessing the increasing irrelevance of monetary policy because central banks everywhere are at the effective lower bound of interest rates. Now fiscal policies are taking the reins. The Fed will prove a good support to maximize fiscal impact by ensuring cheap funding. It makes sense to have a former Fed chair helping to maximize that fiscal-monetary coordination. The long-term implications of the Yellen nomination are distinctly USD negative.
Based on the USD trade-weighted index, the USD appreciated by 27% from July 2014 to its recent peak in April 2020. In terms of length and magnitude, the gains were similar to past periods of USD trends. According to traditional models – based on price levels, productivity differentials, and terms of trade – the USD was about 20% overvalued last April and is still about 10% overvalued.
The EUR is not that expensive – On the surface, the macroeconomic environment does not paint an appealing picture for the common currency. But this should not derail the positive EUR/USD outlook simply because the weak USD story is more dominant. Low eurozone inflation, alongside ECB unwillingness to cut rates further, is a support to stable eurozone real rates. This contrasts with the USD, whose real rates should turn more negative as the economy and inflation recover next year, while the Fed remains behind the curve.
Suddenly the EUR does not look as strong since emerging currencies have rallied. The EUR trade weighted is now as cheap as it was in July. At that time, the EUR/USD was trading below the 1.16 support. This is something that should comfort the ECB over time.
Fed not helped by the leaving Administration – Treasury Secretary, Mnuchin, decided to end 2 lending programs by year-end as he vetoed against the prolongation the Fed asked for. Mnuchin can block/prevent a prolongation of the extraordinary facilities at the Fed, but the next Treasury Secretary will be able to re-implement them. We do not see a lot of drama there, even if it is obviously designed to annoy the upcoming Biden administration. The total corporate credit facility ($750bn) has less than 10% total utilization and has barely been used. It could of course be argued that this sudden stop prevents it from being used, but there are ways for the Fed to provide more liquidity via other channels.
At its early November meeting, president Lagarde made it clear that further easing from the ECB was in the cards on December 10th. The QE Pandemic program will be extended, and the regulations of the bank liquidity program eased. Further policy rate cuts have become less likely as the ECB favors QEs.
Mnuchin decision makes an increase of the Fed QE pace more likely – but not guaranteed given the prospect of Yellen as a successor it could also be through other existing programs. So, the Fed should decide to extend the weighted average duration of its purchases towards 10yrs again.
This could work to temporarily dampen the steepening pressure on the US yield curve, but it may not work as well as in 2011-2012. There are at least 2 major differences to the curve flattening Twist operations in 2011-2012. First, the cyclical macroeconomic backdrop is much more benign now. Then, the Fed will keep adding liquidity, which is an activity booster and hence a steepening support. In 2011-2012, its bond holdings and liquidity were kept stable. Hence, a re-flattening of the curve should be utilized to re-add US yield curve steepeners.
Credit market has still some juice – Corporate credit has largely recovered from the terrible slump prompted by COVID-19. In general, credit spreads are now the narrowest since end of February 2020 and very close to the 2018-2019 period average. At the same time, corporate bond yields are also now near historical lows. If, as expected, profits growth becomes well established in 2021, Investment Grade spreads can still narrow. However, such spread narrowing may be more than offset by higher benchmark Treasury bond yields later in 2021.
On the most at-risk part of the credit spectrum the picture is slightly different. The yield of the US HY market was recently up from November 9 record-low at 4.56%. During the 2017-2019 period, the HY average spread stand at 350bps with a bottom at 300bps. Thus, if a positive outlook for profits growth is sustained in 2021, the HY bond spread might well narrow by 50/70bps in 2021, which ought to be enough to more than offset a likely increase in benchmark Treasury yields.
Good news for equities: Vaccination campaigns will start earlier than planned – Vaccine announcements were widely expected for November, but the very high efficacy of new genetic technology like those developed by BioNTech and Moderna was less anticipated. The other very good surprise comes from the production of vaccines which has already started in November and then the possibility of a national and targeted vaccination campaign from mid-December / early January, 3 months ahead of previous forecasts, with obviously the approvals of the health authorities.
Obviously, vaccines improve visibility of the economic recovery in 2021. The Value segment (low PE ratios) and cyclicals have caught on with price spikes since Pfizer/BioNTech’s first announcement. The green theme benefited from the confirmation of Joe Biden’s victory with the desire for a return of the United States into the Paris Climate Agreement and the appointment of John Kerry as special representative for the climate, and the Boris Johnson’s Green Industrial Revolution.
In the short-term, investor sentiment indicators are at high levels and a reduction in buying momentum would be desirable to get back on a sane track at the start of 2021. Large global institutional investors entered heavily in funds invested in equities upon the announcement of vaccine from Pfizer / BioNTech, the largest inflow ($ 44.5 billion) over a week in the last 20 years, and in October, US individual investors surpassed the historical average of 61% of the share invested in stocks at 66% (source: October AAII Asset Allocation Survey). Other factors could slow the momentum of the stock markets in December, such as the traditional window dressing at the end of the year with the rebalancing of portfolios after the rally in equities or the new regulations coming on GAFA or the acceleration of the pandemic in America of the North and the extension of the Covid measures in Europe or the absence of a recovery plan in the United States or the European institutional blockage on the support plan of € 750 billion. Short-term factors, in our opinion.
But the global vaccination which will accelerate in 2021, the unwavering presence of the Fed with its liquidity and the large stimulus plans are favorable elements to maintain a risk-on position on equities, with an overweighting of the Value / cyclical segment. The appointment of Janet Yellen to the post of Secretary of the Treasury is welcomed, considered market friendly. We are not taking our profits of the Value segment, but after a first violent rally in two weeks, we have now to have an investment horizon of 2 to 4 months; a classic pattern when the bull market for the Value/cyclical segment resumes.
The current high stock market valuations, not shocking in this environment of very low interest rates, will normalize from the 2nd quarter of 2021 with the sharp rise in profits (base effect). In 2021, US profits will increase by 22% instead of the 28% estimated a month ago due to a less pronounced decline in 2020 (strong resilience of companies) than expected with -14% compared to -22% estimated this summer. European profits will fall by 35% in 2020 to rebound by 38% in 2021. Profits in the emerging zone will increase by more than 30% in 2021. PE ratios should return to historical averages. With a six-months view, we forecast a 10% increase of the MSCI World.
In the context of an economic recovery, the European, English, Japanese and emerging stock markets should behave better: the weight of Value and cyclical companies (Finance, Discretionary, Industry, Materials and Energy) is greater compared to the US stock market: Europe 55%, Japan 53%, Emerging zone 54% and US 36%. For the US, the weight of the IT + Amazon, Alphabet, Facebook, a Growth segment, is 40%. The UK stock market has additional strengths such as an attractive market valuation of 14.5x 2021 profits, a possible deal with the European Union and for non-UK investors a likely appreciation of the pound in the event of an orderly Brexit. The European Union should benefit from a more constructive trade relationship with the new US administration.
Emerging countries – Our tactical recommendation at the beginning of November to overweight Latin America, terribly affected by the pandemic, to catch up with Asia is working: the MSCI Latin America rose 23% and the MSCI Emerging Asia ex-China by 10%. Mexico will benefit from the US economic recovery and Brazil from rising commodity prices.
We are maintaining our overweighting on China (A-shares), whose CSI 300 index recorded a good performance of + 20% in 2020. The Chinese economy is experiencing strong growth and the recent upward technical breakout from the lateral corridor in which evolved the CSI 300 since July is a positive sign. The creation of a new Asia-Pacific free trade area, the RCEP, will be positive for the region, namely China, Japan, Australia, South Korea, New Zealand, Burma, Brunei, Cambodia, Indonesia, Laos, Malaysia, the Philippines, Singapore, Thailand and Vietnam.
A weaker dollar, our scenario, is an important parameter for an outperformance of emerging stocks. From March to September, funds invested in emerging stocks saw steady cash outflows, but since the announcement of the vaccines and positive outlook for emerging currencies, investors have been coming back.
Gold – Since early August, the gold price has been correcting, in sync with a rise in real interest rates. Since the beginning of October, there has been an acceleration in physical gold outflows from ETFs.
Vaccine announcements are threatening gold’s bull trend. The prospects for a resumption of overall economic growth make gold less attractive. In the short-term, the gold price will move within a narrow range between the challenges of the pandemic and improving long-term economic prospects, and questions about the development of real interest rates between nominal rates and inflation.
The fall in demand for investment could be offset by the return of purchases by Indian and Chinese households (40% of global gold demand in normal times), largely absent from the 2020 rally due to the pandemic with a drop 30% of the demand for jewelry.
Its cousin, silver, has an attractive industrial future thanks to the rising demand for solar panel manufacturing.
Supercycle for industrial metals – The global economic recovery, the development of the Asian region and the large spending in decarbonizing the economy and green energy will increase the demand for industrial metals.
The demand for metals for green infrastructure will be considerable. The metals mainly concerned by solar and wind will be aluminum, iron ore, silver, indium, nickel, copper and molybdenum, and by batteries and energy storage, graphite, lithium, cobalt and manganese. In its latest report, Minerals for Climate Action, the World Bank is predicting a fourfold increase in demand for metals linked to low-carbon technologies by 2050.
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