Monthly investment review
Global recovery from Q2
Favorable pandemic developments and intense reflation are converging. Expect reopening to occur from spring, favoring the acceleration of activity pace.
Early signs of liquidity peak
In G-4 countries, marginal production of investable liquidity decelerated recently. Global liquidity is also giving early signs of reaching a peak.
G-Zero world. US less centric, China more assertive
The Biden administration is restoring more credible and predictable foreign policy. Still, tensions with China and Russia will perdure coupled with a new framework in the Middle East.
Quality assets will remain scarce and expensive
Despite the current bond market jitters, financial repression is still valid. The pool of quality and low risks assets remains narrow, because of central banks purchases.
Volatile risk appetite. Retail speculation
Recovery will result in further resurgence of equity and bonds volatility. Retail frenzy may ultimately force policymakers to regulate (on margin calls or equity derivatives, etc.)
When the best is the enemy of the good – Vaccination is accelerating, paving the way for a gradual reopening of the economy from Q2 and a herd immunity by year-end in lots of countries. Economic recovery will sharply accelerate. The new American administration is re-establishing many international links and is restoring its credibility. Italy avoided a political crisis by appointing a technocrat maestro.
Bond market implied volatility
All these developments have resulted in a significant rise – about 50 bps – of long-term bond yields in a short period of time (about a month). Per se, this spells a welcome confirmation that recession and deflation risks belong to the past. This will also relieve some pressure on pension funds and life insurance to match their long-term liabilities. Savers and banks would also applaud. But, ultimately, such a multiplication of good news is creating a snag for policymakers and central banks. Indeed, their capacity to maintain ultra-low rates, for a very (very) long time, is under careful markets’ scrutiny.
The pursuit – if not the essence – of financial repression is challenged
End of bonds’ artificial coma – The cost of ensuring / protecting bond portfolio, i.e. the Move index, collapsed in the aftermath of the pandemic. It even remained below the 20 mark for numerous months last year. But the resurgence of adverse developments in the US bond market, not only at the very long end of the curve, is definitely shaking the fixed income boat. This is clearly visible with the sharp rise of the index above 40 in just a few days.
This represents a warning signal for central bankers. They cannot any longer just obfuscate and kick the can down the road, when addressing markets. Actually, this is not just a US story. European and Japanese yields also experienced adverse developments. For now, the ¨damage¨ for global and long-term oriented investors, like endowments, pension funds, and global balanced managers has been very limited, if any. Still, for awfully long duration segments the story is different. For example, a few high-flying IT stocks, among them Tesla, corrected by more than 20% from recent highs. Similarly, the iconic Austrian century bond – maturing in 2117 – experienced a fall of similar magnitude.
Markets are entering the learning zone as they challenge financial repression
World policymakers must urgently adapt / recalibrate their policies
USD leading indicators are heating up – The USD has been volatile for most of February. However, the USD index remains within the range that has held since mid-December, albeit toward the low end of that range. The relative growth, inflation and central bank policy all favor the USD. The fiscal and political outlooks appear more negative, but primarily from a structural / medium-term perspective.
One reason why relative growth looks supportive of a USD rebound is the vaccine roll-out. The US is running at almost double the pace of the EU, which will likely allow the US to lift restrictions earlier. The UK is also a clear front-runner in the Western vaccine race, which is a reason why the GBP has had such a fantastic 2021 start. Both US and UK outpace the EU by miles in the vaccine roll-out. The cyclical indicators, like retail sales or PMIs, too. The latest released Conference Board Leading Economic Index report rose 0.5% month over month. The report could represent an early sign that we are beginning to exit a patch of economic weakness and are set for a reacceleration.
USD trade weighted
It is one thing to say you will accept inflation overshooting, it is another thing to do it once inflation is decidedly overshooting. Inflation expectations have been boosted in the US by the central bank rhetoric and is outpacing European peers. Powell stated the central bank’s easy policy stance was here to stay. The policy is accommodative because unemployment is high, and the labor market is far from maximum employment. The Fed reiteration of a looser for longer policy and the lack of signal of any reduction in bond purchases regardless of the improving economic outlook remains – from an FX perspective – a key point in favor of a generalized USD decline.
Wrong FX market positioning – One of the big moves in FX markets has been the EUR/CHF upside break-out, which is trading at its highest level since October 2019. This is a big vote of confidence in the global recovery. The EUR/CHF is on track to meet our 1.15 year-end target. The CHF certainly sits in the bucket of low-yield defensive currencies. The policy rate has been deeply negative since the SNB abandoned the 1.20 EUR/CHF floor in 2015. Despite this deeply negative rate, EUR/CHF has largely stayed under pressure since March 2018. The SNB has been trying to resist CHF strength with FX intervention. Indeed, massive FX interventions prompted the US Treasury to label Switzerland a currency manipulator. However, everything has changed this year. As confidence is growing in the global recovery, investors are re-assessing their need to hold precautionary CHF long positions.
The bond market selloff dragged central banks communication even more to the fore – While US Treasury yields are in an uptrend since last August, German yields have just recently joined the party. The EUR yields moves is still very modest, however, after a long period of subdued levels, they stand out. It is not difficult to find arguments why long yields should rise more: rebounding economy, huge stimulus measures, large governments supply, higher inflation expectations, booming risk appetite and the reluctance of central banks to cut rates further. Nevertheless, one big obstacle remains as central banks have in theory unlimited ammunition to fight rising yields. The ECB has become worried about the recent rise in yields and Lagarde mentioned that they are closely monitoring longer-term nominal bond yields evolution.
The Fed seems more relaxed and takes higher yields and a steeper curve as a positive sign. While Powell pledged that the Fed would continue its sizable bond purchases, the higher yields are a statement of confidence into a robust and complete recovery. Given another sizable stimulus package is in the pipeline from the Biden administration further, we still see potential for longer US yields to continue to rise.
The general macro environment already suggests yields
The ECB seems very divided. Some Governing Council members have no problem with a gradual rise in bond yields if financing conditions remain favorable and reflect growth and inflation outlooks improvement. Others appear more worried. It remains to be seen how aggressively the ECB is prepared to fight rising nominal yields.
Higher yields risk remains – History has shown that exiting from extremely easy monetary policies can be tricky. Another taper tantrum-like episode cannot be ruled out. In 2013, when Bernanke signaled that the Fed would have to scale back its net bond purchases, bond yields surged higher by 150 bps in just 4 months. While Powell has for now promised that sizable bond purchases will continue, the time to start to tweak that communication may not be that far.
Given the fears of a potentially disruptive taper tantrum 2.0, we strongly suspect that when the Fed will start to taper its asset purchases it will be gradual and involve a “twist” operation, like the Bank of Canada did last year. The BoC recalibrated its QE program by lowering its weekly asset purchases but shifted them towards longer maturities. The front-end will remain pinned down by the Fed’s forward guidance that a rate hike is unlikely before 2023.
US 10-year yield change (in pp)
We continue to think the Fed will remain comfortable with rising yields for as long as they are driven by good reasons i.e. inflation expectations. However, more recently that has not been the case, and we have also seen yields rising on the back of a repricing of Fed hikes. This will be tolerated to a certain degree. This suggests the June 16th FOMC meeting, where a new round of forecasts will be presented, could be the first time the Fed feels serious pressure to clarify its strategy.
A faster yield rise is possible in the Euro area too even if with a lower probability than in the US. In 2015, the German 10-year yield bottomed at close to 0% in April and then surged to more than 1.0% in less than 2 months. At that time, many were expecting the ECB to step in to stop the rise, but it appeared that at least some ECB members were happy with higher yields. Things are naturally different this time, with the ECB more openly targeting easy financing conditions, but such voices could still exist, adding uncertainties.
Cyclicals are back – The rise in interest rates and the likely (desirable) recovery in inflation bring more volatility to the stock markets and confirm the great sector rotation from Growth / High PERs to Cyclical / Low PER. The regime change began to be anticipated in the fall of 2020. There was more talk about Value at the end of 2020, while today investors are more clearly targeting Cyclicals.
Economic recovery is supported by the acceleration of vaccine production and deliveries. After a delayed ignition, 5 billion doses will be delivered in 2021 worldwide. Switzerland will receive all of its doses and expects to be able to vaccinate anyone who wants it by the end of June. Europe can still vaccinate 75% of its population by the end of August. Pharmaceutical companies are gaining momentum and opening new production sites.
The current equity consolidation / correction reflects investor fears of the impact of rising interest rates on stock valuations and the overbought technical situation of the Recovery / Reflation bet, but stocks with high PERs suffer more. A normal transition phase where the Fed should intervene (verbally or materially) to avoid a too strong and too rapid rise in long rates, which would be detrimental to equities. Inflation remains cyclical, not structural. The stock markets are in a bull market with buying opportunities on setbacks. The Fed can’t lose control over long rates, because the world cannot afford a stock market crash after the economic crash.
We are at the start of an economic cycle, more powerful than in the past, and the rebound in corporate profits should overcompensate rising interest rates, as the Fed is unlikely to let the 10-year US slippage. According to a study from The Leuthold Group, stocks tend to rise when interest rates are low (US 10 years below 3%) and when they rise. A study from Robeco, from 1955 to today, shows that an inflation up to 3%-4% is not a danger to stocks. We are on the cusp of a major economic recovery and corporate profits with improved margins: pandemic has favored cost reductions and restructuring. In 2021, company profits of the MSCI World are expected to increase by 30%, by 40% for the Stoxx 600, the Nikkei and Emerging, by 24% for the S&P 500. Investor flows are going towards equities with a clear bias towards cyclical sectors and commodities.
Joe Biden remains in the line of Donald Trump with the search for a return of certain critical production chains in the US, such as pharmaceutical ingredients, semiconductors (foundries), electric batteries, transport and certain metals necessary for the production of cars and military equipment (weapons, planes), in order to reduce dependence on China, observed during the pandemic. This reflection is valid for Europe.
According to Janus Henderson, dividends have shown good resilience in 2020 despite of a decline of 12.2% (- $ 220 billion) to $ 1.260 billion. In North America, dividends rose 2.5% to $ 549 billion, while they fell 40.9% in UK and 31.7% in Europe ex UK. In 2021, overall dividends are expected to grow by 5%. At the end of 2020, S&P 500 companies (ex-financials) had liquidity in excess of $ 2 trillion, suggesting for 2021 higher dividends, the return of share buybacks and sustained M&A activity.
Europe and Japan are in overweighted due to their larger value/cyclical component than in the US. The European economy could rebound more strongly and quickly than anticipated, as the European strategy has been to pay companies to keep employees, unlike the US where the unemployment rate remains very high.
Gold in a corrective phase – Since $ 2,070 in August 2020, gold is in a corrective phase; the price per ounce has lost more than 16% of its value. After breaking a support at $ 1,770, gold should consolidate towards $ 1,680. But the risk is a return to the $ 1,470- $ 1,370.
Recently, gold has suffered from rising real interest rates, but also from the stability of the dollar. Gold is also in strong competition with industrial metals, which have risen sharply since March 2020, initially thanks to the Chinese economic recovery, and secondly with expectations of economic recovery in developed countries and ecological transition, very greedy in industrial metals. There is also the bitcoin craze and other cryptocurrencies that seem to be an alternative to gold for some investors.
Conversely, over the same period, silver, palladium and platinum performed better with performances of –8.6%, +2.5% and +18%. It is the industrial bias and the green theme that resurface. Platinum and palladium are used in the manufacture of catalytic converters for unleaded gasoline vehicles, while sales of diesel cars plummet. In 2020, platinum supply was lower than demand. The story of platinum will continue with the come-back of hydrogen; platinum will play a key role in electrolysis and fuel batteries. Unlike catalytic converters where either palladium or platinum can be used, only platinum can be used in hydrogen. Platinum is 30 times rarer than gold and 80% of production is in South Africa. However, there is the risk that the battery electric car will dominate the market, and there will be no need for either palladium or platinum. As for silver, its demand will increase in solar panels and wind power due to its high efficiency in electrical conductivity; silver has been in a supply deficit for several years. The most attractive precious metals are therefore silver and platinum.
Cross Gold / Silver
The price of copper has doubled in a year thanks to the economic recovery in China and expectations of a strong global recovery post-Covid. Copper is also in a supply shortage. In the short term, the technical situation is overbought and some Chinese brokers have amassed large speculative amounts, not just copper. We expect consolidation in the short term, but we are maintaining our Supercycle for industrial metals. Glencore recognizes that the increase of demand will put pressure on output. The evolution of the dollar will also be a determining factor.
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