Exposure rates of the Dorval Asset Management Range – 23rd October 2020

An asymmetrical W-shaped curve is more clearly emerging as the economic scenario in Europe (cf. chart 1).

The severity and duration of the fourth quarter dip will be dictated by the extent of restrictions required to stabilize the epidemic, which is very tricky to predict at this stage. However, if we look beyond Europe, the situation is much more encouraging.

 

An asymmetrical W-shaped curve for the European economy

Real GDP for European countries (OECD Europe)

 

The short-term economic outlook is deteriorating in Europe, as we see increasingly widespread curfews and even fresh lockdown measures in Ireland and Wales. Restrictions currently being rolled out may still be enough to stem the tide: two or three weeks should be sufficient to tell, and in this case the economic cost would be moderate. However, the likelihood of fresh rounds of restrictions out to the end of the year has increased considerably, and this would have a significant immediate economic impact – although not as severe as in the spring. European governments clearly will endeavor to keep as much of the economy open as possible: for example production facilities and building sites are unlikely to grind to a halt given the use of masks and testing.

 

Looking further afield, bad news coming out of Europe is offset by more upbeat developments elsewhere in the world (by way of reminder, Europe accounts for 25% of the world economy), as the virus remains under control in Asia, and we are seeing a significant easing in case numbers in India and Latin America.

Lastly, in the United States, current restrictions are not hindering the economy’s momentum, with October’s composite PMI soaring to 55.5 and hitting its highest point since early 2019. A fresh fiscal stimulus program is expected after the elections, and a particularly hefty package could be announced if Biden wins and the Senate moves into Democrat hands in a so-called blue wave scenario: this is one of the factors driving up US long rates.

 

Approaching US elections and surge in epidemic in Europe
pushing US and German yields apart

Yield on 10-year Treasury / Yield on 10-year Bund

 

Looking to the financial markets, investors reacted to bad news from Europe by buying German bonds (cf. chart 2), but the equity markets held up well. Market psychology is now less prone to panic, as past experience has shown that both governments and central banks were perfectly able to take on a hefty portion of economic and financial risks. Meanwhile investors realize that news on the epidemic situation can change very quickly, either with the announcement of vaccines and/or treatments, or with stabilizing Covid-19 caseloads.

 

Lastly on the European equity markets, listed companies in total generate almost half of revenues outside Europe, and this also curbs risk.

 

In the current environment, we have slightly cut back our portfolios’ exposure to European equities, while in the near future we may make other tactical adjustments depending on how the epidemic develops in Europe and on the east coast of the United States, and subject to the outcome of the forthcoming US election.

 

However we are still convinced that the world economic recovery in 2021 will be the dominant theme for the medium term, even if the virus is still around. We believe that Covid-19 will have an increasingly limited economic fallout as a result of the improvement in procedures to keep the epidemic under control (as we are seeing in Asia) and as both consumers and producers adapt to the situation. The scenario would be even more positive for the most cyclical sectors to boot – particularly services – if a feasible vaccine and/or a treatment were announced.

 

 

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