Where to turn post Covid-19?
This content is for professional investors only as defined by the MiFID.
By Gilles Seurat, Multi Asset Fund Manager, La Française AM
In a post Covid world, there are plenty of unknowns, especially about the virus itself: when will we develop a vaccine, will the world face a second wave, etc.? These are all very sensitive topics that continue to drive investors’ risk appetite – each news article referencing a vaccine is literally cheered by financial markets. Unfortunately, it is extremely difficult to get an edge on these issues – even doctors seem puzzled.
However, there are some things we do know that can contribute to building our asset allocation.
Governments seem to be spending as much money as possible. Deficits are widening to record highs: for 2020, -9.6% forecasted for the Eurozone as a whole, -17.4% for the US, -13% for the UK. (Source: Bloomberg) And it looks like this is only the beginning. Just as central bank quantitative easing has been extended/increased multiple times, governments will probably spend more in the future if growth disappoints.
Today’s spending clearly translates into a significantly higher debt to GDP ratio tomorrow. This extra debt will have to be paid back eventually, and it will certainly weigh on future growth. This means monetary tightening is not an option, as governments just will not be able to afford higher rates.
Before the COVID-19 crisis, we already considered that rates were capped due to long-term trends such as digitalization and ageing populations. Now, the picture is even clearer: get used to negative yields, because they are here to stay. In the current context, long-term Australian government debt, where the yield curve is steep, is an option.
Currencies are also affected. The US dollar has lost its shine – carry is now minimal with deeply negative real interest rates. This bear trend means that inflation expectations will continue to recover from the deeply depressed levels we observed during the crisis. We are therefore positive on breakeven inflation in Europe and in the US.
Regarding risky assets such as stocks, there is an ongoing tug-of-war between terrible economic performance and dramatic fiscal and monetary easing. However, investor positioning gives us a clearer signal regarding investor sentiment. While investor sentiment has improved, it remains relatively weak compared to historical data: cash levels are high, systematic strategies such a “volatility targeting” funds are running low levels of risk and even the hedge fund beta relative to the S&P500 is on the low end of the range. To us, this means that the “pain trade” is higher for risky assets, which all other things equal, are bound to creep higher. We favor financial subordinated debt (AT1s), as well as corporate credit (both investment grade and high yield). Bonds have underperformed derivatives during the crisis and therefore have room to catch up. In the periphery of Europe, we follow closely Greek bonds, which exhibit an attractive risk/reward profile and are now purchased by the ECB in the PEPP.
In equities, our preference goes to large caps which have suffered far less than their small cap peers. The bear dollar trend should mean better returns, on a currency hedged basis, from US stocks.
This commentary is intended for non-professional investors within the meaning of MiFID II. It is provided for informational and educational purposes only and is not intended to serve as a forecast, research product or investment advice and should not be construed as such. It may not constitute investment advice or an offer, invitation or recommendation to invest in particular investments or to adopt any investment strategy. Past performance is not indicative of future performance. The opinions expressed by La Française Group are based on current market conditions and are subject to change without notice. These opinions may differ from those of other investment professionals. Published by La Française AM Finance Services, head office located at 128 boulevard Raspail, 75006 Paris, France, a company regulated by the Autorité de Contrôle Prudentiel as an investment services provider, no. 18673 X, a subsidiary of La Française. La Française Asset Management was approved by the AMF under no. GP97076 on 1 July 1997.