House View, August 2020

Macroeconomy

We have revised up our euro area GDP forecast for 2020 to -8.5%, mainly due to improving data in Germany, which is better positioned to recover rapidly from the downturn than its European peers. Meanwhile, the US economy has shown signs of flatlining amid escalating covid-19 cases in the South. Consumer confidence has taken a hit, while weekly unemployment claims have been rising again. This confirms our prudent scenario for the US recovery (i.e. not a ‘v’) in spite of the prospect of fresh fiscal stimulus.

Data show the Chinese economy rebounded strongly in Q2.GDP expanded 3.2% y-o-y, led by manufacturing, compared with a -6.8% slump in Q1. Sequential growth may moderate from its Q2 high, but the recovery in services could speed up. As a result, we have upgraded our 2020 GDP forecast for China to 1.8% from 1.2%. The solid recovery in the Chinese economy lends further support to our constructive stance on Chinese bonds and equities.

Asset Allocation

Hard and soft data, a deal to expand common debt issuance and a relatively disciplined approach to the coronavirus pandemic are all casting a more positive light on euro area assets and the euro.

Euro area stock indexes, which have lagged their US peers, will benefit from substantial fiscal stimulus and the chance of a broad economic recovery. European clean energy and infrastructure stocks could do well, whereas US stocks carry slightly higher valuations (adjusted for sectors and growth rates) and face the uncertainty of the November elections.

Combined with cheap valuations, the recovery of the Chinese economy has led us to move away from our underweight stance on Asian equities. In corporate debt, while we continue to avoid speculative plays, central bank support means we are selectively looking at ‘fallen angels’ as well as ‘green’ bonds.

Commodities

Oil had a good run in July, reflecting drops in oil supply and a rise in demand. However, the big improvements in daily mobility data were showing signs of tailing off toward the end of the month, leaving us comfortable with a year-end price target of USD40 for Brent crude.

Currencies

We expect the US dollar to remain under downward pressure as the currency’s growth and interest rate advantages have been deteriorating. By contrast, the euro’s prospects have improved, thanks in part to advances on mutualising euro area debt. The Japanese yen continues to offer a relatively attractive real yield.

Equities

At time of writing, about two thirds of S&P 500 companies had reported Q2 earnings significantly above expectations, with top- and bottom-line surprises at record highs. In addition, more companies provided guidance for the current quarter than for Q2. Results in Europe have been suffering from provisioning by financials. Equity valuations are demanding (22x forward earnings for the S&P 500), although supported by low bond yields. We remain slightly underweight equities overall.

Major emerging-market economies like India and Brazil have yet to flatten the curve of virus infections, and the road to recovery from the pandemic may be longer for most EM economies than for advanced ones. However, the progressive reopening of economies worldwide is proving a tailwind for EM equities, and a depreciating US dollar in particular. North Asia remains a bright spot as the industrial recovery in China gains steam.

Alternatives

The severe economic downturn caused by covid-19 represents an opportunity for private-equity firms, which are able to deploy capital on more attractive terms than before.

Fixed Income

US and euro 10-year sovereign yields remained low in July and corporate spreads moved closer to more ‘normal’ levels. Central bank support will maintain government yields low and ensuring that credit markets continue to function properly. While economic recovery will be supported by massive fiscal stimulus, we expect corporate defaults to increase (although not as much as before).

We prefer investment-grade corporate bonds and maintain a quality bias in high yield, while we recognise investment grade’s strong recent really and the risk of higher sovereign yields could impact total returns going forward.