Modest risk reduction, looking for entry points

Tuesday 03 March 2020

Global Investment Views, Fixed income, Equity

Download the Complete March Global Investment Views

Contributing Authors

Pascal Blanqué
Group Chief Investment Officer,
Amundi

Vincent Mortier
    Deputy Group CIO, 
Amundi

The spread of COVID-19 outside China has rattled risk assets in the recent trading sessions. Investors triggered some profit taking in markets, which reached historical highs and even broke psychological thresholds in previous weeks. The atmosphere of fear has remained consistently high only in the so-called safe assets — the USD, UST and gold — signaling that investors have been looking for effective hedging strategies. Our central scenario is for a temporary deterioration of the global economic picture in Q1 of this year, with some possible spill over into Q2, given that weaker-than-expected global trade growth is ultimately affecting industrial production and manufacturing activity and there are some impacts on the internal demand. Later on, we should see a recovery over the remainder of the year. Overall, we have downgraded global growth to 3.0% from 3.2%.

Clearly, the main risk now is the unwinding of recent market complacency and the reaction of “animal spirits.” The good run in risky assets has been driven by investors who believe (1) the COVID-19 episode will be temporary (our central scenario); (2) a worsening situation will trigger more Central Bank (CB) action; (3) they have no alternative, given the moves of safe-haven assets. Therefore, we can expect to see some profit-taking, short-term market volatility and overreaction.

A tactical move towards neutrality in risk exposure and an increase in hedging looks to be a good strategy to navigate this phase. Beyond that, COVID-19 must be seen as a way to implement our investment convictions, exploiting entry points in some areas of the markets such as the cyclical value component in European equities (already attractive, but even more so now), EM equities (help-yourself-countries or domestic-demand stories) and EM currencies. All these stories will be back in focus once the virus-headlines recede. In addition, falling core yields will likely reignite the search for yield in credit or in higher-yielding government bond space in EM and DM (e.g. Italy). We should also not underestimate the fact that if the situation worsens, CBs and governments could start to use stimulus on a massive level, renewing the narrative of bad news is good news. Fed’s recent inter-meeting emergency rate cut of 50 bps is a step in that direction.

As main areas of risk and opportunity lie in credit, the main question for investors is: To what extent will the coronavirus generate non-idiosyncratic disruptions? We expect resilience in the credit market, in particular EU IG, but we expect divergences between good quality names and bad quality names, which could come under stress. This reinforces our view of an increased scrutiny in credit, focus on bottom-up research and a rise in attention on liquidity.

From a long-term perspective, coronavirus reinforces some pre-existing trends:

  • De-globalization and retreat in global trade should support insulated investment themes, such as domestic-demand driven EM countries or a focus on more domestic real assets.
  • Low interest rates at equilibrium. Core US bonds are providing a cushion for risky assets in reaction to setbacks, but they are also leading the rebound of risky assets. It follows that duration management must be asymmetric: it is much more risky being short duration than long duration, and there is a clear hedging-role for US Treasuries. In this scenario, the interest rate factor dominates the growth and earnings components of equity returns. Investors should be alert to the early signs of either a change in equilibrium rates or a shift pointing to more prominence for the real component of returns versus the monetary component, but we are not yet at this point.
  • Demand for real assets. The absence of real illiquid assets is a recurring weakness as they represent an already large, but rising component of relative value plays. De-globalization is driving demand for real estate on the basis that it provides significant international geographical diversification. The search for a better remuneration of the interest factor (infrastructure) or simply equity-like returns with bond features is also driving demand. This mismatch in supply and demand, along with trade and pandemic noise, can only accentuate this sort of safe-haven status with fast rising complacency.

Fixed Income: High selectivity in credit, but there are opportunities

Contributing Authors

Eric Brard
Head of Fixed Income, Amundi

Yerlan Syzdykov
    Head of Emerging Markets, 
Amundi

Ken Taubes
    Chief Investment Officer, US, 
Amundi Pioneer

 

With elevated uncertainties on the macro side and investors’ continued search for safety, we expect the core government bond yields to remain very low, with limited upside pressure. Negative yielding debt is back to US$14tn in value and this continues to push investors towards the 'oasis of yield' in credit, securitized assets and peripheral debt.

Here, a close look at the evolution of the macro economic situation is crucial. While abundant macro-liquidity supports financing of corporations, a deterioration of the economic environment could affect the most leveraged areas of the market.

DM bonds

In global fixed income, we maintain a slightly positive bias on duration, with a preference for the long end of the curve and flattening. We continue to prefer US, despite some profit-taking, as safe-haven demand is likely to support UST. Elsewhere, we have a short to neutral stance on core Euro duration (negative on Germany) and a short one on Japan and the UK as fiscal stimulus is likely to push rates higher and the BoE is likely to keep rates on hold. EU peripheral countries continue to offer attractive yields and we are constructive on Italy. Investors can also play curve flattening opportunities in Euro peripheral areas and steepening in the UK. Credit remains an area of opportunity for us but selection is crucial. EUR IG has been resilient and we continue to prefer it vs US IG as the former should benefit from the ECB program, in particular in the subordinated debt financial sector. In HY, EUR remains our favored pick over US. Overall, we suggest investors to partially reduce the credit exposure to make room for additions in the future.

In the US, solid economic data and corporate earnings have helped propel credit spreads to near all time tight levels before coronavirus risk erupted. Tail risks to economic growth remain, potentially weighing on credit fundamentals. As a result, we are cautious and selective overall. In US credit, while we realize that prospective returns from securitized credit would be lower after last month’s strong performance, we continue to favor securitized over unsecured due to the former’s better risk/return profile. Structured securities, including non-agency RMBS and consumer debt, remain attractive vs most other IG sectors. Given that employment, wealth and confidence are strong, and as fundamentals in the housing market remain positive, low mortgage rates should boost home sales, prices and affordability. Spreads in the agency MBS are attractive, but their potential for further tightening is limited owing to the net supply impact of the Fed’s dwindling MBS holdings.

EM bonds

We remain constructive on HC bonds, notwithstanding the risks from the coronavirus and the US election cycle, as the technical backdrop remains favorable and monetary policy easing along with fiscal stimulus should be supportive. We prefer select high-yielding names such as Indonesia, Ukraine and South Africa. In LC, we think valuations have become less attractive and there will be some negative impact from currency weakening. Nevertheless, we continue to see pockets of value, especially in frontier markets.

FX

We maintain our cautious view in aggregate on EM FX, particularly regarding currencies more exposed to a further slowdown in Chinese growth and currencies of commodity exporting countries such as Thailand and Chile.

Equity: Volatility will reinforce bottom-up selection

Contributing Authors

Kasper Elmgreen
Head of Equities, Amundi

Yerlan Syzdykov
    Head of Emerging Markets, 
Amundi

Ken Taubes
    Chief Investment Officer, US, 
Amundi Pioneer

There is an elevated uncertainty regarding the short-term outlook for global equities. The coronavirus outbreak will weigh on economic growth this quarter and next. There is some political risk — underestimated in case of US election — and the expected earnings rebound will likely be postponed. Despite this short-term challenge, we expect the economy to rebound once the most acute phase is over. Moreover, the dovish stance of central banks and fiscal stimulus should support a manufacturing stabilization and improvement in the outlook for equities. It’s important to note that US markets, in general, are more defensive in a weak environment for equities. But as soon as the situation stabilizes, investors who are cautious in this phase, should exploit opportunities in the most dislocated areas of the market (EU and EM equities). Bottom up selection is extremely important, to navigate the markets in this phase.

DM equities

In European equities, we did not change our main conviction that price dislocations in the cyclical value space are an opportunity for bottom up investors. For the overall market, due to the deterioration of the economic outlook, earnings growth is critical for future performance. The situation in China has created new headwinds and a completely accurate assessment of its potential impact is not easy. We have used market volatility to favor companies where we are convinced about strong balance sheets and resilient business models. At a sector level, we have become more positive on banks and industrials among cyclicals, and health care among defensives, and we are less positive on energy. We believe markets are expecting too much from the IT and consumer staples sectors, making us cautious in these areas.

In the US, we think markets are too optimistic about the macro-economic situation and underestimate the political risk. Although an earnings rebound will likely be delayed, earnings should eventually improve later in 2020 on the back of lagged effects of lower interest rates and input costs (lower energy prices). This would benefit the consumer-dominated US market. Higher earnings are likely to support our conviction of cyclical value outperforming growth, but this should happen only when the manufacturing recovery materializes. We are cautious overall on the market at the moment. At a sector level, we favor relatively conservative (less cyclical) cyclical names in financials and industrials. In healthcare, we realize that the meaningful discount that existed in the sector when candidate Elizabeth Warren’s chances peaked last summer has now corrected and value is no longer obvious, especially with drug pricing legislation likely to come up soon in US Congress. We are cautious on IT (expensive valuations), consumer staples and utilities sectors.

EM equities

We are selectively positive on EM equity with a medium term perspective. We focus on companies related to domestic consumption that are relatively insulated from the coronavirus story and those that can potentially benefit from strong domestic demand or the continuing shift in the value chain (Russia, Indonesia, Vietnam). On the other hand, we have become very cautious on Chinese tourism-related sectors such as hospitality, aviation and consumer discretionary. In this regard, we are defensive on companies listed in countries such as Thailand, Korea and the Philippines that are beneficiaries of demand from Chinese tourists.

Important Information

Unless otherwise stated, all information contained in this document is from Amundi Pioneer Asset Management (“Amundi Pioneer”) and is as of March 3, 2020.

The views expressed regarding market and economic trends are those of the authors and not necessarily Amundi Pioneer, and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading on behalf of any Amundi Pioneer product. There is no guarantee that market forecasts discussed will be realized or that these trends will continue. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested.
This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any service.

Date of First Use: March 3, 2020.