Monthly investment review

November 17, 2020 - 15 min read

Strategy and Macro

Asset Allocation

  • Subpar growth, disinflation.
  • Resumption of intense liquidity injections by the Fed
  • Growth: temporary relapse. More uncertain U-shape pattern
  • G-Zero world. Multilateralism and climate action in the waiting room
  • More healthy capital flows
  • Quality assets will remain scarce and expensive
  • Normalization of risk appetite, lower speculation


Macro perspectives

Covid-19 and politics spell further policy (re)-action

A second wave of pandemic is underway in Europe and in the US. Seasonality – i.e. cold weather – is not favorable for its containment. Partial mandatory lockdowns, as well as more cautious attitude from the Private sector, are likely in Q4. The eventual authorization of vaccines in coming weeks will not suffice to turn it around as a) public mistrust is significant b) large-scale production and distribution will take months.

A so-called ¨Blue Wave¨ did not happen, as Democrats disappointed in Senate contests. Consequently, a scenario of a President Biden with a Republican Senate, remains a risk. It would reduce the odds of a major fiscal stimulus plan like the Blue Wave would have produced. Another scenario, i.e. a contested election, would result in tentative recounts and possible implication of States and Federal Supreme courts.

The Fed put itself on the sidelines from last September. This was legitimate considering elections, markets’ recovery, and early signs of speculation (Robinhood like). From now, Powell & Co are likely to resume supporting markets after this legitimate pause. Time will tell whether it will ¨simply¨ implement the same prescription as in Q1. It is quite possible, as it owns lots of ammunition regarding the potential size of programs it unveiled in S1. Or it could opt for different / complementary actions in the realms of New Monetary Theory. This would be particularly appropriate in case of a long-lasting / nasty political gridlock.

The expected U-shape recovery in G7 is at risks
Some electoral confusion may continue up to Harbor Day.
This is more a side show than a risk
The Fed has no choice but to resurface as the leading driver of monetary policy accommodation


The identity of the next President will count a lot

Indeed, a constructive cohabitation between Republicans and Democrats is improbable. Therefore, major issues like global trade, security, climate will depend on the new President.

With Biden, a lowering of trade barriers between Western and many Asian countries surrounding Pacific will reinvigorate global trade

A Biden presidency would pave the way for a rejuvenation of the Trans-Pacific Pact. But no doubt, tensions with China (which does not belong to it) would remain.

Ironically, the US just left the Paris agreement early November. Among our three scenarios, only a Biden presidency would allow for a US reintegration. Pathetically, the US is the first country to officially leave the Paris Climate Agreement.

Fortunately, this major cause will progress even in the US quicker under a Democrat President



Weaker USD outlook remains unchanged

Looking through the short-term uncertainty associated with the potential contested outcome, even a Biden presidency and republican senate still points to a weaker USD outlook, mainly for 2021 once we are through the tough winter period. This is because:

The US fiscal stimulus, albeit smaller and delayed, should be nevertheless delivered. Lower probability for tax hikes should be positive for risky assets and thus, by extension, support risk currencies against the safe-haven USD. There is likely to be an end to unpredictable trade wars and a return to a rules-based system for international relations, being less supportive for the USD.

The Fed will remain behind the curve, given its new average-inflation targeting framework, leading to low US real rates for long.

Granted, the scope for gains in cyclical currencies and a more pronounced USD sell-off is thus more limited given the anticipated less aggressive US fiscal spending. Risk appetite is likely to remain a key driver of the USD into year-end.

The EUR has benefitted from improved investor sentiment since the May agreement on the Recovery Fund. EUR has recently eased amid confirmation of delays in the launch of the first tranche of the €750bn fund until Q2 2021.

The ECB is aware that there is little it can do to combat EUR strengthening if it is principally driven by external factors. Euro area real yields are not projected to fall further sharply anytime soon. Inflation is negative (Sept −0.3%) and European second-wave shutdowns are dampening growth. Given the current focus on real yield, it should also support further near-term EUR appreciation. In addition, Purchasing Power Parity estimates imply the EUR is currently undervalued vs. USD. Various models using producing prices and the Big Mac index quantify its undervaluation at 7% vs USD.

The Bank of England has slightly surprised the market by announcing a larger-than-anticipated expansion of its QE to £150bn throughout 2021. Risk management have pushed policymakers for a strong early reaction. What the markets really want to know is whether there will be a shift to negative interest rates in 2021. For the time being, the BoE is offering no fresh hints. That is not particularly surprising. There is scope for further easing in 2021, particularly if the switch to new UK-EU trading terms proves to be messier than expected. But there still appears to be a lack of consensus. Governor Bailey summer comments suggested he thinks QE is a much more useful policy tool than negative interest rates.

While the yuan has rebounded all the way from the record low of near 7.2 per dollar since late May, there may still be room for further appreciation. The yuan will continue to strengthen against Asian currencies. This is based on the acceleration of global de-dollarization amid the continued dollar-printing from the Fed, along with Chinese ongoing economic recovery to lure further capital inflow. However, a new trade war cannot be ruled out if the US or other countries hold China accountable for the Covid-19 outbreak and step up trade tariffs. In the long run, the CNY possible rise as another major reserve currency may be a structural tailwind for currency strength.



A slower reflationary process

No action was taken by the Fed at its latest meeting as it favored to wait and see until December and until an election result is found. It was never really an obvious timing to do anything at the meeting due to the timing just after the election. The total flexibility of the QE program is already in place. The Fed can just increase purchases in between meetings if necessary.

It is not carved in stone that an Operation Twist will lead to a much flatter curve. The Fed is still buying at least $80bn of Treasuries a month. A QE program, and in particular an Operation Twist, is designed to compress the term premium, but the added liquidity usually increases the probability of a reflationary growth comeback. This is why there are effects pulling in opposite directions. Empirically, the curve has almost always steepened through QE programs as the reflationary liquidity effect has outshined the negative effect on term premiums. We doubt that the curve will re-flatten markedly in an Operation Twist scenario, but it could contain the steepening.

The Fed average inflation targeting strategy is aimed at getting inflation back to 2.0% on a sustained basis. We assume that the Fed has a reasonable credibility on inflation. Patience in raising interest rates and a tolerance of the economy running hot underpin the new strategy. The Fed guidance indicates that it will accept an inflation overshoot beyond 2.0% until its average target is achieved on a sustainable basis. Based on FOMC forecasts, PCE inflation will not return to target until 2023. If the Fed is successful in engineering higher inflation and the overshoot is symmetric with the undershoot, then the Fed should not raise rates before 2024. In the meantime, market-based measures of inflation expectations should climb.

In the near-term, we expect legal maneuvers around the election result to somewhat depress stimulus hopes. The upside US 10-year yield risks has diminished and will be postponed.


Supportive credit supply and demand.

Credit spreads are trading close to their historical average. Technical factors will remain key drivers. On the demand side, central banks have been the main player in town, and will stay. The ECB preannounced for December a new package that will include an expansion of its Pandemic purchasing program by €500bn into end-2021 to €1850bn. Its classical QE may also be upscaled and completed by further liquidity operations. The Fed has been buying corporate bonds for several months to keep bond markets open, stop a potential wave of bankruptcies and keep yields as low as possible. It has also purchased IG debt and later added some HY bonds and will continue to do so.

On the supply side, companies issued over $900bn bonds between April and August, more than double the previous year volume, taking advantage of low funding costs and high investors demand. Since then, a large part of debt issuers have changed their mindset. Most of them have already decided to paydown a large part of their debt to reduce their financial leverage. Furthermore, companies are reprioritizing shareholder returns, one of the largest discretionary uses of cash over the past years. Buybacks and dividends have fallen to half or less of cash from operations for BBB rated companies. That compares with 60-80% in 2018.


Search for yield will support HY

The US HY 12-month default rate was 8.5% in October, well below the 11.2% forecasted in April and lower than in September. Investors were also anticipating a wave of defaults comparable with the financial crisis, when the HY default rate reached 14.7%. So far, defaults have been contained thanks to the central banks and governments decisions, which delivered cash to households and made it easier for businesses to borrow to stay afloat. Consumer spending has also morphed/adapted.
The HY issuers have a financial leverage equal to 6.1 times their EBITDA, the highest level on record. If earnings continue to recover and issuers to pay down some debt with the cash raised earlier in the year – as a precautionary measure – average leverage levels will rapidly decrease.


Covid-19 an EM stifle

Despite the significant disruption, EM spreads have traded in a narrow range for the past 3 months, after tightening significantly since the once-in-a-decade wide in Q1, mainly thanks to central banks support programs.

China is engineering a fast rebound thanks to massive fiscal stimulus and improvements on the internal demand front. But many other countries’ recoveries have been more gradual. Portfolio flows into EM markets have recently spiked supported by debt flows. The main beneficiary is China, thanks to its inclusion in most of the bond benchmarks, international investors have pilled billions into it.
Despite weaker fundamentals and spread tightening, some EM stay attractive. Sovereign debts stand to benefit from supportive lending programs and near-zero rates. Otherwise, despite positive real yields, attractive valuations and a light positioning, the appetite will stay limited. Many countries have limited policy room for further conventional monetary easing or further fiscal stimulus, given their already large fiscal deficits and deteriorating debt metrics.



A deep and serious economic and sanitary

But investors are looking towards 2021. The V-shaped economic recovery in China confirms their anticipation. The rise in stock indices relies on anticipations of fiscal and budgetary plans to support and revive economies, on monetary policies of central banks and the arrival of vaccines. The US Federal Reserve kept saying, some had forgotten in the hubbub of the US presidential election, that it would do whatever is necessary to support the economy and thereby (our interpretation) support equities.

The US results for 3Q20 are better than expected and positive guidance is increasing. Expected to fall by 21%, US profits will only decline by 10%. In Europe, profits will drop by 26.6%, but European countries are in a process of confinement and temporary curfew due to pandemic. But the rebound in profits in 2021 will be even greater: it is estimated at +40% in Europe and +23% in the US. For the next two months, we prefer to upgrade to neutral US equities in our tactical allocation and reduce European equities to neutral; due to the binding Covid measures in Europe, the economic recovery will be delayed by one quarter. Once again, Europe risks to be behind with a €750 bn relief plan not sufficient and a ratification in national parliaments not yet started.

The Joe Biden’s victory (not decisive) increase the odds of Democrats’ economic stimulus plans (rather expected for February 2021) which will favor the Value/cyclical segment (banks, industry, materials, hotels, restaurants, air transport, energy) and the green thematic. Perspectives for Value/cyclical are also interesting thanks to low valuations. See graph below. To this will be added vaccines, some of which will be authorized by the end of 2020, although vaccination in developed countries is not expected before the 2nd quarter of 2021.

The dark side of the Democrats will be an increase in the corporate tax rate from 21% to 28%. We do not know when it will set up; 2021, 2022? In a need for financing relief plans, this increase could be well accepted by the market in the short term. However, the impact on profits will be significant, and perhaps investors haven’t yet given it much importance in this unique health crisis and the nasty noise of the US presidential election. Lipper Alpha calculated a negative effect of 10.7% on S&P 500 profits; it had been positive with +12% in 2018 (for a total increase of 25%) with the tax reform of Donald Trump. To this will be added the negative impacts on capex and share buyback programs for earnings per share. The sectors most affected will be energy, real estate, technology, FAANG and pharma, and the least affected will be banking, materials and consumer staples.

Investors will start to take an interest in companies that have recorded a (very) large drop in profits due to the pandemic, because by 2Q21 there should be a very positive comparison effect. Inversely, Covid-proof, stay-at-home, work-at-home companies will see a negative, or even very negative, comparison effect; this concerns, among others, FAANGs, technology and e-commerce.

We are becoming more cautious about the 4 Big Tech which perceive increasing political pressure. In the US, the Justice Department is seeking to initiate the Sherman Antitrust Act to break Google’s monopoly, and some US states are also evaluating legal actions against Apple, Amazon and Facebook. The US Congress is also very active. For the first time, Apple reports a significant financial risk (in billions of dollars) linked to legal attacks on its App Store; Google has the same problem with the Google Play Store. Scheduled for early December, the European Commission will present a new legal regulation on digital, the Digital Services Act, mainly concerning Big Techs to ensure a fair competition where they will not be able to do anything in the short term; this will concern the management of content and private data, as well as ensuring a fair competitive environment. The United States and Europe are very likely to force Big Techs to change their business model. The legal battle promises to be long and complex, but the United States has shown that it can bend the behemoths (Standard Oil and AT&T). A matter of time. The stock markets don’t like uncertainty.

Chinese President Xi Jinping took advantage of the Golden Week celebrations to give the new economic vision: dual circular economy, domestic consumption, self-sufficiency, more added value in the industry and reducing technology dependence on the United States. With a strong economic recovery, started in March (good management of the pandemic) and the start of a global vaccination campaign, Chinese indices should continue to rise.




Gold prices have been consolidating since early August. Investors are still net buyers, although there was a neutralization between buyers and sellers in October, but rising real interest rates (the most determining factor for the evolution of the price of gold ), the fall in demand in India due to the pandemic and the net sales of central banks in the 3rd quarter (the 1st time in 10 years) explain this consolidation / correction.

Between 2010 and 2019, consumption (jewelry) accounted for 52% of global demand, investment (funds / ETFs in physical gold) 28%, central banks 12% and industry 8%. In 2020, consumption fell, accounting for 27%, offset by investment which represents 55%. In consumption, India’s weight fell from 24% (2010-2019) to 17% due to the cancellation of celebrations and weddings, and that of China remained stable at 30%. In 3Q20, central banks were net sellers for the first time since 4Q10, especially from Turkey and Uzbekistan, a global movement linked to the pandemic and the economic crisis; they profit from the high prices.

In the medium term, gold remains a hedge against inflation which could resurface with unprecedented economic stimulus plans and currency debasement associated with the gigantic debts contracted by states to cope with the impact of the pandemic.

The widening US deficits could translate into a weaker dollar while a favorable situation for gold. A return to $ 2,100 an ounce medium term remains a preferred scenario.


Industrial metals

Industrial metal prices follow China’s economic recovery, knowing that it consumes 50% of the world’s supply. They also benefited from an aggressive speech by President Xi on the need to promote domestic consumption, reduce technological dependence on the US, adopt a strategy of self-sufficiency and increase the added value of consumers. industrial products. Xi plans to double the size of the Chinese economy by 2035.

Industrial metals are also anticipating gigantic economic stimulus plans that will translate into spending on traditional and green infrastructure. The bet on reflation is also a bet on the rise in commodity prices.

The transition to a carbon-free economy will increase the demand for industrial metals, for solar panels, wind power, batteries, the transformation of buildings, which contribute 40% of greenhouse emissions, construction and sustainable transport, smart electricity grids, etc …



Demand is gradually returning and world oil stocks are declining. The eia estimates a normalization of these stocks in 2Q21 and then OPEC producers and Russia will be able to increase production again. We maintain crude prices between $ 50 and $ 60 in 2Q21. Containment measures in Europe are less severe than this spring. Stock prices of oil companies correlate with crude prices, but the Democrats’ victory is not a favorable factor.

Asset allocation

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