Quarterly investment review

April 08, 2021 - 13 min read


The financial markets have continued on their Q4 2020 momentum. Long-term interest rates have continued to rise, the equity markets have reached new multi-year highs, in the United States, but also in Europe and in Japan, and gold price has continued to decline.

The most notable change is in the US dollar. After several months of steady weakening, the trend was abruptly reversed with the official election of Joe Biden as the new president of the United States and the announcement of new stimulus packages.


The US government is taking over from the central bank

Central banks – led by the US Federal Reserve – flooded the market with liquidity throughout 2020. The Fed has repeatedly called on the Trump administration to take over. Just seven weeks after his inauguration, newly elected President Joe Biden signed a $ 1.9 trillion stimulus package. The pandemic has claimed more than half a million lives in the United States, and the world’s largest economy contracted 3.5% last year, its worst year since World War II.

With the green light from Congress, millions of Americans will receive direct aid checks totaling some $400 billions. The plan also extends exceptional unemployment benefits until September, which were due to expire on March 14th. The law also devotes 126 billions to schools, from kindergarten to high school, to support their reopening despite the pandemic, as well as 350 billions in favor of states and local communities.


Stock markets set new records

After contracting 3.5% in 2020, the global economy is expected to grow 5.6% in 2021, 4.1% in 2022, before returning to its long-term potential in 2023 at 3.5%. The main factors behind this rebound will be basis effects as well as the numerous stimulus packages.
Global interest rates continued to rebound. The US 10-year interest rate has already erased the panic phase of 2020, and is back close to the level that prevailed in 2019. It is currently trading around 1.70% after flirting with 0.3% at the worst of the crisis last year. European long rates are slowly coming back to 0.0%, with the German 10-year rate trading at –0.30%. The stock markets continued to rise. The S&P500, the flagship index of the New York Stock Exchange, is flirting with the 4000 points mark and is trading at its highest level ever. However, the contributors to this assessment have not been the same as last year. The energy, banking and telecoms sectors outperformed the tech and automotive sectors. Gold continued to decline in the wake of the rise in real interest rates and the rebound in the USD. In a context of sustained economic recovery and return of interest rates to satisfactory levels, the need to hold gold is less justified.




The announcement of new plans to support the US economy has favored the recovery of the US dollar against all currencies. The two big losers are emerging currencies and to a lesser extent the EUR. The ambient risk appetite in Q1 allowed the CHF to finally depreciate.




Rising global interest rates led to a general pullback in bonds, with the government component taking precedence over everything else. Only the European and American high yield segments managed to post a positive performance. The other exception being Chinese government bonds which benefited from their natural decorrelation.




The MSCI World index, the global equity index, posted a positive performance of +4.5%. The so-called “value” markets clearly outperformed the US market, led by Europe and Japan. At the same time, emerging markets have been penalized by the USD rise and political and geopolitical tensions.




Oil price also continued its rebound in the wake of production cuts announced by the OPEC+ countries. Gold, for its part, fell sharply and posted its worst quarterly performance since the 4th quarter of 2016.



Global trade resumes

Global trade rise

Global trade was estimated to be 15.0% higher than a year ago in January. It is the first time that growth has reached double digits since the early 2010s. The global economy is fully recovering.

However, growth was driven in the main by a surge in Chinese exports. Recent data indicated an average increase in Chinese exports of 60% over the first two months of 2020.

Regional divergences are also notably apparent, with growth seen in key Asian exporters (Japan, South Korea) but some weakness persist amongst European nations.

Global trade is nonetheless up around 10% on equivalent 2019 volumes.


Growth disparities

Leading indicators are rebounding

Leading economic indicators point to the US outperforming among the largest developed economies. Growth resumed in the UK and Eurozone leaving only Japan in decline. The growth disparities reflect differing COVID-19 containment measures, but also vaccine roll-out progress. Stimulus measures likely also played a key role, notably in the US.

Economic indicators showed business activity in the US rising sharply in Q1 2021, rounding off the economy’s best performance since Q3 2014. Indicators are pointing for a strong economic growth of around 1.5%, or approximately 5% on an annualized basis.

Impressive growth was also recorded in the UK as business activity rebounded. Indicators are pointing to a modest decline of GDP after the 1.0% expansion seen in Q4 2020. Growth also perked up in the eurozone, led by Germany. The eurozone should deliver a stable economy growth, improving from the 0.7% fall in GDP seen in Q4. Japan lagged the other major developed economies.

A common theme among all developed economies is the persistent recovery of manufacturing led by a record surge in the eurozone. Japan’s producers reported the second-strongest gain since 2018. The UK saw a marked expansion of production. The US printed a contrasted image in this improving manufacturing trend, recording the weakest expansion of production since last October. However, the slowdown appears temporary, linked mainly to supply disruptions – which hit a record high.



Towards less Financial Repression and Asset Price Inflation?

  1. Higher odds to exit Pandemic and crisis management. The timing to achieve a global herd immunity is uncertain, featuring significant disparities among countries / regions. While developed countries should reach it by end-2021, a few large emerging countries will still suffer into 2022.
  2. The Biden administration is revisiting its economic (redistributive) and foreign policies (coalition for China containment). The adoption of ambitious complementary plans in H2 would exacerbate tensions of market’s (long-term) interest rates. New taxes – less markets friendly – are unavoidable.
  3. Cyclical inflation. Oil and other cyclical raw materials prices are resurgent. Supply chains bottlenecks continue. A pronounced base effect will happen from Q2. We may experience an unbridled pickup of headline CPI in H2 2021, if pent up demand resurges strongly.
  4. Bubble formation. Financial repression and unabated liquidity injections have favored speculation and leverage. Policymakers have become growingly concerned about retail investors’ frenzy, SPACs, as well as sky-high property prices. Some central banks (Japan, Canada, New-Zealand) are preemptively reducing the intensity of ultra-accommodative stances, while the Fed is trying to dodge the issue. Noticeably, the PBoC and ECB will maintain their current stance.
  5. In the next 5 years, we will experience a broad adoption of digital – central bank – currencies. The launch of a crypto/e-Yuan is close (Olympic games in Beijing 2022 latest). The global fight against cash is accelerating. Euro and Yuan will growingly challenge the supremacy of the USD.

Financial conditions are still accommodative Liquidity pick Is close



New USD driver

US outperformance is USD supportive

Historically, large US Twin deficits have driven the USD lower. Over the past 50 years, each time the twin deficits have worsened, the US economy has rebounded.

The 3 last episodes were under the Reagan, Bush Jr and Obama administrations. Most of the times larger twin deficits have pushed the USD significantly lower. The only exception was under Reagan. At that tie, the main reason was that those deficits have been strongly productive. The US GDP growth sharply turned back above the 5.0% hurdle while in the 2000s it failed to achieve a significant economic boost.

The Fed just confirmed it is not in any hurry to hike rates or taper its bond purchase program. This puts the Fed in a more hawkish camp when compared to its peers such as ECB or RBA which are promising to become even more aggressive.

The recent $1.9trn Biden administration plan has pushed a lot of strategists to lift their economic growth forecasts. According to Bloomberg, it has been revised up to 5.6% from 3.9%, in less than 3 months, for 2021 and to 4.0% from 3.1% for 2022. The latest $2.2trn Biden support plan announcement should cause another upward revision to US growth.


Tide is turning for USD/CNY

Chinese yield pick up is reducing

The Yuan has recently outperformed most of its partners. The only exception is the USD. In S2 2020, tailwinds have supported Chinese assets, the winds are changing direction. In fact, the path may turn into a steeplechase with a growing number of obstacles in front of the Yuan. The slow vaccination rates, a lower international demand for equities, and a less compelling relative value of Chinese government bonds are all negative factors. Now, trade and geopolitical tensions are popping up on the radar again. Exports require two sides, and as many parts of the world still struggle to overcome the pandemic, foreign demand for Chinese assets will struggle to revolve at the same pace.



Has the Fed a yield cap in mind?

Relationship between long-end yields and Fed scenario

The US Treasury index are off to their third-worst start to a year since 1830 pushing yields back to their one-year highest levels. Powell had one opportunity to quell investors’ nerves. The US 10-year yield is already up 75bps since January. Could it soon reach 2.0%, or 2.5%, or even 3.0%?

The Fed only controls short rates, while longer-term ones are more prone to move based on economic growth and inflation expectations. But that is not to say the Fed has no role to play. Since 2012, its favorite forward-looking tool is the “dots,” which shows the Fed funds policymakers’ expectations for the next few years and longer term. The long-term neutral rate is also influenced by non-monetary drivers like workforce growth, labor productivity, global supply, and demand for safe and liquid financial assets. Economic growth this year will be good if not spectacular. Pent-up demand and savings could revive long-dormant inflation and get the Fed away from the zero-lower bound within the coming years. Few would argue that the neutral rate should be higher than it was just a few months ago.


Credit spreads big squeeze to continue

Credit spread per unit of leverage

With fixed income, it is not always easy to determine whether investors are appropriately compensated for the level of risk they are taking by providing liquidity to issuers. Equity investors have ratios such as PE. Credit investors generally look at spread levels and financial leverage to assess the attractiveness of bonds.

Spreads are not too far off their tightest levels of the past 20 years. Given the amazing amounts of central banks supports, resulting in $14trn of negative-yielding debt, and ample fiscal stimulus, it is not beyond the realms of possibility to see spreads to tighten more this year.

Therefore, we focus on fundamentals to assess long-term debt sustainability. Leverage deteriorated considerably in 2020. Net debt slightly increased while earnings collapsed. As it is a backward-looking measure, we are yet to see the earnings improvement in corporate balance sheets. Consequently, using spread per unit of leverage i.e. the median net debt to EBITDA ratio, spreads appear to be stretched.



From a liquidity (2020) to a fundamentals driven market (2021).

Equity risk premium

The formalized regime change from disinflation to reflation, the sharp rise in earnings, with positive surprises, will support stocks, even if interest rates rise. The equity risk premium (1/PER – US 10Y) is in neutral area even with sharp increase in equity indices and in interest rates.

Studies show that a rise in interest rates often coincides with a bullish stock market, up to a certain level. According to an analysis by The Leuthold Group over the period 1900-2020, stocks most often rise when the US 10-year is below 3% and rising. According to Bank of America, the last 19 rate hike cycles since 1920 have seen the S&P 500 rise 74% of the time with an average performance of 13.3%. During the last 5 cycles of the US 10-year increase since 1998, the S&P 500 has recorded an average performance of 30.2%, with banks leading the way. Other analyzes, like that of Robecco (see graph below), show that US inflation between 2.5% and 3% is not a negative factor. On the other hand, inflation above 4% is starting to weigh on indices. Today, US 2/5-year inflation expectations stand at 2.7%.


A normal volatility rise in the current phase of the cycle

Value-Cyclical should outperform

To fund these stimulus measures, increasing the corporate tax rate from 21% to 28% and penalties for companies that park their profits in tax havens should result an underperformance for FANGs, we are thinking at Amazon, Apple, Facebook, Alphabet, and some pharmaceutical companies.

In 2020, risky assets benefited from extraordinary liquidity injections from central banks. A pure liquidity market, resulting in low volatility. Then, the prospect of a gradual exit from the health crisis with the arrival of vaccines triggered a rise in interest rates and revived inflationary expectations, causing a significant sector rotation from Growth/Defensive to Value/Cyclical. The phase of rising rates and inflation expectations precede the recovery in corporate profits. Unless the pandemic drags on with its dangerous variants, cash injections, which peaked at the end of 2020, should make room for fiscal stimulus, meaning more volatility and outperformance of cyclical stocks.



Gold is facing headwinds

Gold, silver and inverted real yields

Expectations of a strong economic recovery in the United States are reflected in a rise in long-term interest rates and the dollar. Investors maintain their bias on risky assets. This environment is not favorable to gold, a defensive, monetary and non-yielding asset. Investors continue to exit ETFs and other funds invested in gold. The negative correlation between gold and US real interest rates continues.

Between September 2017 and August 2020, gold rose 75% and outperformed silver thanks to strong demand from central banks in emerging countries. Russia had sold all of its US Treasury bonds in favor of gold. Turkey, China and Kazakhstan had also been major buyers. However, since the second half of 2020, they have slowed down or stopped their gold purchases.

Since September 2020, gold has been in a corrective phase. Silver seems willing to break away from gold. A number of structural and cyclical (economic recovery) industrial factors (industry accounts for 50% of demand) should allow silver to outperform gold.

The industrial demand for silver will increase with the policies of decarbonization of the planet, the electrification of cars, solar panels and 5G. Silver is irreplaceable in the development of photovoltaic cells thanks to its excellent stability and high conductivity. The Silver Institute predicts a 9% increase in demand for gold in 2021.


Economic recovery supports oil

fiscal break-evens

The price of oil is gradually rising with the recovery of the global economy, the OPEC+’s output squeeze (45% of world production) and the reduction of world inventories.

Global commercial inventories have eased after a peak in early 2020. A brent price between $65-70 is in line with the current level of inventories.

OPEC+ maintains its restrictive production quota, considering the overall economic situation still fragile. It expects demand to increase from 5.8 million b/d in 2021 to 96 mbd, which is still below the 100 mbd of 2019.





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