House Views - November 2020 - Surf's up

Macro
In the past few weeks, new COVID-19 cases have accelerated across much of Europe and the US, followed by rising hospitalisations and fatalities. Business confidence remains high in the States but has begun to slide recently in Continental Europe, particularly in the services sector. Many governments now look likely to implement lockdowns – perhaps on a short-term basis, to ease pressure on hospitals – and economies now face the risk of a double-dip recession. Asia looks set to remain the exception to the rule – Q3 GDP growth in China has accelerated to 4.9% year-on-year with no discernible sign of a second coronavirus wave.

Central Banks
The expected slowdown in growth is likely keep a cap on inflationary pressures across the globe. In the euro zone for example, core inflation – i.e., ex food and energy – has only risen 0.2% in the last twelve months. Central banks stand ready to ease policy further to mitigate the fallout from the pandemic, but we do not expect the Federal Reserve (Fed) and European Central Bank (ECB) to move until their December meetings. In all likelihood, the easing will come in the form of enhanced and extended asset purchase programmes – of government and high-quality corporate bonds – to ensure that borrowing costs remain under control.

Markets
Subdued inflation and central bank buying are likely to keep most sovereign yields low, that is to say in negative territory after inflation, although emerging market government debt does offer attractive additional yield (or “carry”). Investment grade corporate bonds (IG) pay a sufficient yield premium (or “spread”) to offer positive real yields but caution should be exercised with more speculative high yield bonds (HY) where sluggish growth is likely to impair credit quality. That leaves equities as our preferred asset class for the long term. However, near-term headwinds remain a source of risk and volatility. 

Bottom line
No change to our fixed income allocations where we continue to highlight the relative value in higher-quality corporate bonds compared with sovereigns in advanced economies. Within equity markets, we have further reduced exposure to Europe given the impending dip in activity and persistent uncertainties surrounding the future trade relations between the EU and the UK. On the other hand, Asia is emerging relatively unscathed from the pandemic and we expect China’s growth engine to pull other regional economies it its wake – we have moved to a strong Overweight in emerging Asian equities. Regarding commodities, we have downgraded oil to Underweight and continue to prefer gold.

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