Investors’ positioning cools off, but the recovery scenario remains valid - Dorval's Macro Corner (September 2020)

"Adapting economic knowledge to market realities and breaking free from the tyranny of indices"
François-Xavier Chauchat
Member of the Investment Committee. Macroeconomic framework and asset allocation.

The price correction on the Nasdaq, the clear upturn in Covid-19 cases in Europe and the procrastination on the US budget have caught investors cold. There is no shortage of uncertainties, but the arguments for a constructive view of equity markets remain fairly strong.
The virus seems at this stage to be well under control in China and most of Asia, it is finally on the decline in Latin America, and in the West the death rate of the epidemic is a clear downtrend, which allows less disruptive management of new waves of cases (while waiting for a vaccine). Driven by the stimulus packages, the global economic recovery will continue until at least the end of next year, and interest rates will remain at rock bottom levels for many years to come. The members of the US Federal Reserve do not plan to hike interest rates until 2023, and the Bank of England is bracing for the possibility of negative rates. In Europe, some ECB members are starting to call for new measures to counter the anxieties linked to the second wave of Covid-19 cases.
The tide has clearly turned in favor of durably more expansionary economic policies. Even though it has been delayed, it is very likely that a new US stimulus package will emerge regardless of the outcome of the election. While waiting for further measures, Western households have considerable savings to deploy, which will continue to support spending on durable goods and household equipment, building construction, etc. Structurally, finally, a long cycle of investment driven by energy transition and digital acceleration (5G) has begun.
In the equity market, the optimism accumulated by investors this summer has become a headwind. It decreases the potential for good surprises and makes markets more vulnerable to bad ones. However, risk-taking on the markets seems to have been less strong and generalized than during the last two exits from the recession in 2009 and 2013. The recovery of the stock markets has indeed remained very focused on the winning stocks of the crisis (with localized bubbles) and those who have benefited the most from the decline in interest rates.
As Europe and Japan were already in a zero interest rate situation before the crisis, this lower interest rate effect was especially noticeable in the United States. But with the US market becoming more expensive, an attempt to diversify portfolios seems to have recently started. Non-US markets are doing better relative to Wall Street. In Europe, small caps are starting to outperform again after a long period of investors’ disinterest.
Investors are aware that the risks could be reversed in favor of the neglected sectors by the announcement of a vaccine, or when the European epidemic peak is reached. Both of these events are expected in the fall. In this context, our international portfolios remain very diversified, with a bias in favor of the most cyclical sectors. To deal with short-term uncertainties, we have initiated a position in 30-year US Treasuries, and we have moderately re-exposed our portfolios to the US dollar (against the euro).

Download Dorval’s Macro Corner of September 2020 in PDF version here

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