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Investment note: Time to look forward

24 June 2020

In this note, the Amundi investment team led by Group Chief Investment Officer Pascal Blanqué and Deputy Group Chief Investment Officer Vincent Mortier, says while the data isn’t pretty, it’s time to look forward.

Covid-19 has triggered a sequence of economic and financial market narratives and is giving way to a new status quo characterised by extreme fiscal and monetary measures, to which markets have responded well, though some volatility has returned in the past few days.

In effect, these policy measures are painting a new picture, that of a “day after” renaissance. Markets have already priced in their rosiest scenario: the end of the worst of the virus cycle, the possibility that a second wave will be weaker than the first, and a cure and vaccine arriving fast and becoming broadly available before a new pandemic pushes the economy into a fresh wave of lockdowns.

Some recent data supported this view, such as the PMI bottoming out (still weak) and the US job market surprising on the upside (though it is trending down).

Overall, the data isn’t pretty, but the general idea is that the economic freeze is almost over and that it’s time to look forward. This is what has pushed the equity markets to almost erase year-to-date losses in the US, with the S&P 500 (Total Return) down 2.7% YTD, after a QTD performance of +21%, as of the close on 17 June. Recently, a strong rotation clearly showed up in favour of cyclicals, small caps, value stocks and laggards. There has been a race to follow the trend, favouring the lagging markets such as Europe, Japan and EM assets, and corporate credit is also attractive.

In the “day after” scenario, the expectation of low bond yields and massive central bank buying also works in favour of a relative preference for equities vs. bonds as dividend yields outstrip bond yields. It’s true that earnings growth expectations are still too high, but if we think the worst is over, that there’s no juice in bonds and liquidity abounds, we have no choice other than to look at equities to try to grasp opportunities in areas that haven’t fully recovered their pre-crisis valuations.

However, the road along the recovery phase could be bumpy. So far, only those companies most directly affected by the lockdown measures have gone bankrupt. But the race against time between solvency and liquidity continues. There will likely be more victims, and many downgrades are still to come.

Expectations that the pandemic is over may be too optimistic, and any slip-ups could heat the markets up again.

While it’s true that governments and central banks have introduced extreme measures, more will be needed, particularly outside the US, where the magnitude of measures doesn’t match the economic damage.

Moreover, the risk of policy mistakes can’t be underestimated. The money available has to be targeted efficiently, and too much haste to secure electoral consensus could result in a misallocation of capital. Geopolitics will increasingly take centre stage the further we move toward the final phase of the US Presidential election.

Against this backdrop, we recommend the following guidelines at the level of portfolio building:

  • Maintain a balanced risk exposure and play the rotation toward value and cyclical stocks. The markets were too fast in pricing the end of the lockdown and the recovery ahead. Current valuations -are the result of a liquidity-driven rally and are being sustained in the short term only thanks to the continued aggressive monetary expansion. Markets are clearly addicted to CB liquidity at the moment, but in the second part of the year a reality check on earnings growth has to be considered. Therefore, we suggest combining a high level of liquidity with some exposure to cyclical assets that offer high performance potential in the event that a favourable scenario plays out.
  • Stay positive in the credit space, which is benefiting from fiscal and monetary measures, and very selective. IG credit and the better-quality BB companies in HY will remain the sweet spot in a climate of a slow recovery, very low rates and rising defaults. Investors should seek opportunities in the IG primary market, where activity is at a record high. We expect the default rate to increase for low-rated HY issuers, and this is not fully priced in by the market, so selection is paramount in the HY space.
  • Liquidity is, has been, and will be a key variable in the new order. Keeping liquidity buffers is particularly important in this phase, as a second leg-down in the market can’t be ruled out. This will provide room to move into segments and markets that display attractive entry points.

For investors, this means we can’t ignore any “day after” directions, but we must also exercise caution and selectivity. Don’t move from depression to euphoria, but from uncertainty to navigating a careful path forward.

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