Looking at recent economic data releases, it appears that the worst of the crisis is now behind us. Indeed, activity re-started in May and has been picking up since with the gradual reopening of economies. However, while encouraging, the recovery will be staggered and slow, and it will take a long time to get back to pre-crisis levels. The initial bounce from lockdowns is strong, but data remains below early 2020 levels and we still need confirmation that it will not taper off after the initial post-confinement excitement. Moreover, according to consensus estimates, GDP across most major economies might not reach 2019 levels until 2022 at the earliest. Nonetheless, markets have latched on to the “less-bad-than-expected” data to continue to march forward, although we do appear to have entered a consolidation phase.
First, while the reopening has so far been managed with the virus mostly under control in Asia and Europe, a number of US states are seeing a rise in cases, leading to fears of a second wave and a second confinement. We continue to believe that these spikes are area-specific and that hospitalizations will remain manageable for healthcare systems. We also believe that renewed lockdowns are unlikely at this stage. Nonetheless, headline risk remains and could lead to market turbulence. Moreover, as we move towards Q2 data and earnings releases, disappointment risk continues as markets are pricing in a V-shaped recovery, which is unlikely to materialize seamlessly. Finally, a lot of good news is already priced in, suggesting it might take even better news for the next meaningful leg up. As such, we choose to remain prudent and do not believe it is time to become overly aggressive in our allocations, even if we believe that high cash levels, a bearish consensus, and of course massive fiscal and monetary stimulus suggest the downside has become more limited.
While volatility could rise again in equity markets, we expect fixed income to remain well-behaved, thanks to virtually boundless central bank support. Credit spreads have continued to recover, and while they could also stabilize before resuming their tightening path, we still see potential for compression on a medium-term basis. We maintain a preference for investment grade (IG) credit over high yield (HY) where risks persist, though selective opportunities exist. On a selective basis as well, we see opportunities in emerging market debt, particularly in the less volatile corporate space that also benefits from a bias towards Asia rather than Latin America, where significant COVID challenges remain. We expect sovereign yields to remain within a broad range and believe that central banks will succeed in keeping yields contained for some time to support governments’ stimulus efforts.
We believe that gold should remain supported by abundant liquidity and very low interest rates for a long time, which makes the shiny metal’s lack of yield a lesser hurdle. We also continue to look at less liquid alternative strategies to diversify our longer-term perspectives.Equities
Equity markets have continued to advance on better economic data releases and expectations for a V-shaped recovery but now appear to have entered a consolidation phase, as concerns that this idyllic scenario may not unfold as expected, second wave fears, second quarter earnings and trade tensions weigh on sentiment.
Nonetheless, we believe that the downside has become more limited given how many investors missed the rebound, how many remain bearish and how much cash has been sitting on the sidelines. Coupled with abundant stimulus measures and liquidity, corrections are likely to be bought. That said, we remain prudent and believe it is too early to add a lot of risk to portfolios.
We believe that European assets can continue to play catch-up with the US in the short term and maintain some exposure to European financials that should benefit from confinement easing and further integrations thanks to the Recovery Fund proposal. We remain underweight on emerging markets given a number of significant concerns surrounding the COVID crisis in many large economies, and have a preference for emerging Asia region.
While we believe the next few months could be complicated, we maintain our more constructive medium-term view and look to gradually build longer-term positions.Fixed Income
Bond markets remain well-behaved thanks to central bank actions, keeping sovereign yields within a broad range. We expect this trend to continue and yields to remain stable, but we maintain a slight underweight position to sovereigns, as we prefer credit. We believe that peripheral spreads can continue to tighten as Europe comes together from this crisis and as the prospect of European Commission issuance should provide an additional boost.
We are overweight US and European investment grade credit but remain more cautious on high yield as the extent of the damage from the crisis is still unknown and default risk remains. In addition, central banks are likely to favor protecting IG over HY, acting as a stronger backstop for the former. Spreads have already recovered a large part of the March widening, and could consolidate for some time, but we believe they will continue to compress over the medium term.
We see select opportunities in emerging market debt, particularly in hard currency corporates that are typically less volatile and have less exposure to Latin America. However, given difficult situations in many countries, selectivity is key. We believe emerging market currencies should benefit from the dollar weakening, but find the space too volatile given poor economic backdrops.Currencies
The US dollar appears to be stabilizing after its recent slide, but could continue to slide as the dollar liquidity squeeze we saw in March eases and risk appetite strengthens. Nonetheless, we expect it to maintain some underlying support. Sterling could see more volatility, as the crisis has not been handled well and fears of a hard Brexit may come back since little progress has been made on trade negotiations with the European Union. Emerging market currencies should benefit from a weaker USD, but idiosyncratic risks remain and volatility should be expected.Commodities
Oil prices have recovered from their lows, but are likely to remain capped given ongoing oversupply and a slow pick-up in demand. Over the medium term, prices should rebound further as supply and production balance out, but we still expect supply to remain ample. Gold should continue to see underlying demand as a safe haven, given inflation expectations and central bank quantitative easing (QE)1
We continue to see a place for alternatives in portfolios, as we look for de-correlating and diversifying strategies to complement traditional asset classes, particularly with liquid alternatives. We believe that real assets can also help provide income in a lower-for-longer world.
1 Quantitative easing (QE) refers to monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed are as of June 25, 2020 and may change based on market and other conditions.
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