The speed of vaccination against Covid-19 has been remarkable in the developed western world. In six months, hopes of recovery have thus become reality. However, the revival of the economic outlook is accompanied by uncertainties, the main ones being the withdrawal of monetary support, economic overheating and possible inflationary slippage.
The economic shock due to Covid-19 has led to a rebound in line with our expectations. Thanks to monetary and fiscal support, the economic upturn and improving earnings supported rallies in most stock markets. As a result, absolute valuations are high in both equity and credit markets. We reflected this recovery in the portfolios by favoring risky assets, in particular cyclical and value-style equities, as well as carry strategies and alternative asset classes, more particularly real estate and infrastructure.
At this stage, the most important risk remains the evolution of the pandemic. Despite the rapid deployment of vaccination in most developed economies, vaccines are fewer and less effective in a large part of emerging countries. This disparity gives rise to uneven economic recoveries and increases the risk of new variants.
Inflation remains a matter of concern. However, the surge in prices will remain limited to the sectors affected by the pandemic, and we see no signs that inflation is more than normalizing. Central banks in general, and the Federal Reserve in particular, will use a broader approach, including a more complete recovery in employment, before raising policy rates.
Geopolitics retains its potential to influence markets. The Biden administration has returned to American commitments at the international level and we are seeing an easing of trade tensions with the European Union, as well as the start of a new dialogue with Russia. On the other hand, a nuclear deal with Iran would pave the way for its return to international oil markets. Nonetheless, the long-term relationship between the United States and China will remain competitive and potentially volatile.
In the short term, our focus is on balancing recovery and pandemic, inflation and political support. These tensions will create more volatility in the markets.
For investors looking to preserve their earnings, optional put spread equity index strategies can be attractive. At the time of writing, the VIX index, which measures equity volatility (S&P 500), is at around 15%, which is close to its pre-pandemic levels, offering the ability to buy options at an affordable level. In the event of a decline in the markets, which in our opinion could be of the order of 5 to 10%, put spread strategies can constitute an effective portfolio hedge. This approach is consistent in a context where it makes sense to take advantage of stock market declines to increase exposure to equities.
Finally, the pandemic sheds light on social inequalities and the threats weighing on our climate. Over the long term, we see unprecedented opportunities for our clients to invest in the transition to a net zero emissions economy.
Ten convictions for the second half of 2021
1. Stay invested in risky assets
The strong macroeconomic recovery and stimulus measures support risky assets, especially those that are sensitive to the business cycle. Although this momentum is likely to run out of steam in 2022, this stage of the cycle continues to favor equities over bonds., as long as corporate earnings remain strong and valuations attractive.
2. Continued outperformance of cyclical and “value” stocks
This environment of solid growth and transient inflation points to high single-digit yields for the coming year, with a possible increase in volatility in response to changes in US monetary policy. . Valuation levels will be further challenged by the rate hike, but we continue to expect earnings to grow. This scenario supports the cheap sectors which are recovering, in particular energy, finance and autos. While most cyclicals are currently trading at higher levels and offer a more balanced risk / reward ratio, “value” stocks will be supported by above-trend economic growth, rising rates and steepening. US yield curve.
3. Preference for European and British equities
As a result, we are concentrating our overweightings in equities on pan-European stocks that are sensitive to the economic situation. Indeed, the latter should benefit the most from the reopening of economies, the acceleration of the rise in profits and attractive valuations. Eurozone and UK stocks are still trading at relatively cheap multiples, despite their exposure to the global recovery and reflation theme.
4. Rising yields should cause the curve to steepen in the second half of the year.
Over the next 12 to 18 months, we expect long-term government bond yields to rise gradually as the economic environment normalizes. Since the Fed is unlikely to tighten monetary policy until mid-2023, we would expect these hikes to be visible first in long rates, which should lead to a steepening of the yield curve. On a 12-month horizon, US Treasuries and German 10-year Bunds are expected to reach 2.25% and 0.25% respectively. In this context, we favor a low exposure to sovereign bonds as well as a defensive duration. Improved economic growth is likely to support credit fundamentals, in both developed and emerging markets.
5. Use carry strategies to generate income
Despite a recent tightening in credit spreads, we continue to identify value in carry strategies, high yield credit and emerging country hard currency debt. We continue to favor spread risk over duration risk, with Chinese renminbi debt offering diversification virtues, solid fundamentals, good credit quality and attractive yield, as well as a low correlation with rates. Americans. We also like emerging corporate bonds, which should benefit from improving economic fundamentals and reduced leverage, while offering strong yields and spreads.
6. The US dollar will depreciate while the euro will benefit from the growth momentum
Despite the Fed’s projections for a key rate hike, we still expect the US dollar to depreciate moderately in the second half of the year. We base this analysis first on the fact that according to our estimates the dollar remains overvalued by 20% and second on the continuous improvement in global activity and international trade, two factors that have historically led to a weakening of the greenback. The rotation of the growth momentum towards Europe, the reopening of the region’s economies and the EU’s “Next Generation” fund should support the euro with improved confidence and increased portfolio flows. A less accommodating Fed, and / or any delay in European reopening following the appearance of the “delta” variant, would compromise these prospects.
7. The conditions remain in place for a strengthening of the renminbi
We maintain our positive view on the renminbi given continued positive portfolio flows and strong exports. The recent increase in foreign exchange reserve requirements by the People’s Bank of China suggests that it aims to slow, rather than reverse, the pace of appreciation of the Chinese currency. We believe this reflects the large build-up of onshore currency deposits during 2020, which could be converted back to renminbi, and therefore we maintain our year-end forecast for the USD / RMB exchange rate of 6.22. This presupposes an improvement in Sino-US trade relations. The main risks stem from a slowdown in exports or the prospect of even higher tariffs.
8. The price of gold will fall due to the rise in real rates
We continue to underweight gold as the rise in rates and renewed risk appetite should continue alongside the economic recovery. Although inflationary pressures pushed the price of the yellow metal up during the second quarter of 2021, the recent change of course by the Fed has reminded us that real rates remain the main driver of the movement of gold prices as part of the recovery. As these inflationary pressures are expected to prove transient and nominal rate expectations rise, there remains a risk of falling prices. Considering long speculative positions that could ease, and despite an expected modest dollar depreciation, we see gold at $ 1,600 per ounce (USD / oz) by year end.
9. Infrastructure spending offers the opportunity to “build back better”
Alternative assets continue to play an important role in terms of return and risk diversification. The Biden administration’s historic spending plans and the EU’s “Next Generation” stimulus package promise strong capital inflows and investor interest in sustainable infrastructure. We are maintaining our overweighting in infrastructure, as this asset class is expected to be one of the main beneficiaries of post-pandemic government spending. In addition, European real estate should continue to recover, thus providing additional opportunities for investors.
10. Invest in the transition to a net zero emission economy
Investors will increasingly integrate the transition to carbon neutrality into the prices of financial assets, resulting in shifts in market sentiment towards long-term winners and losers. Consumer behavior is already transforming many sectors and we believe that a thematic approach favoring the most advanced companies on the path to a net zero emission economy makes sense for investors. Investment strategies should reflect this transition by prioritizing solution providers, as well as business models in carbon-intensive sectors that work to reduce their emissions in order to meet the goals of the Paris Agreement.