House Views - August 2020 - One step at a time
We note continued divergence between “soft” economic data (i.e., confidence surveys) and “hard” reports on actual activity – the former reflect the move from lockdown to resumption of some activity while the latter show that industrial production and retail sales remain well below end-2019 levels. We continue to register new highs in COVID-19 cases across the globe – especially in the US sunbelt and Latin America – suggesting that lockdown restrictions will only be eased slowly, thereby ensuring that recovery from the recession will be gradual. As a result, government attention across Europe and the United States is now shifting from support measures to recovery stimulus plans.
We see little chance of a shift in monetary policy settings, which are set to remain very accommodative for the foreseeable future. In the US, the Federal Reserve (Fed) is discussing ways to anchor rate expectations close to zero for the next few years while continuing to buy up much of the Treasury issuance to finance support for households and businesses. The European Central Bank (ECB) will hold rates negative and is using the flexibility of its Pandemic Emergency Purchase Programme (PEPP) to boost holdings in periphery sovereigns. It has also improved terms on its long-term refinancing operations to provide a lifeline to embattled banks.
Central bank purchases will keep government bond yields low while also supporting high-quality corporate bond spreads (the yield differential over sovereigns). We remain more wary of lower-quality issuers in the High Yield (HY) segment given the default risk, although the abundance of liquidity does provide some support to highly leveraged firms. Equity markets offer more long-term potential, although the sharp rally since late March means further upside may be constrained in the short term. We expect the euro to continue its recent recovery against the dollar, given attractive valuations and lower risk of new lockdowns.
We maintain a broadly diversified, balanced approach to asset allocation. Much of the recent rally in equities has been driven by a small number of internet and tech giants, especially in the US, and we would balance exposure to these leaders with other sectors and markets. Within our Neutral exposure to equity markets, we maintain a preference for the euro zone, and highlight the attractions of Asian technology groups – in terms of growth and valuation – within emerging markets. Investment Grade (IG) corporate bonds remain a preferred Overweight within fixed income while low-yielding sovereigns offer little diversification benefit or upside potential. Our preferred offsets for equity risks remain gold and hedge funds.