MARKETS IN 3D: DELTA, DECELERATION AND DIVERGENCES

Just released latest Global Investment Views.

Equities have remained buoyant over the past weeks despite some challenges (China regulation, Afghanistan crisis), primarily due to the exceptional earnings seasons in the US and Europe. Looking ahead,?we identify three main themes: the spread of the Delta Covid variant, the deceleration of economic growth from its peak, and divergences in policies. On the first D, Delta, the resurgence of Covid-19 cases in the US and Europe has been a key topic, with the return of the so-called lockdown trades penalising travel and leisure stocks and favouring more defensive companies. We believe that the market has probably gone a bit too far with regard to pricing in the potential for new lockdowns. This may have opened up opportunities in the most affected sectors.

The fear of global spread of the Delta variant overlaps with the second D, a deceleration in economic growth already in process, both in the US and China. The EZ, in contrast, is still climbing the hill, with the peak likely to be reached in the next one or two quarters, lifted by the periphery, in an inflationary environment that remains more benign than for the US. All these factors translate into diverging monetary policies among the US, China and the Eurozone. In the US, the acceleration in the job market recovery, coupled with higher inflation, is paving the way for tapering talks. China looks to be moving towards an easing bias, and the ECB remains broadly accommodative. Also, the fiscal side could play relatively in favour of the EZ in the coming months, but in US, most of the fiscal accommodation is behind us and the infrastructure plan will take years to become effective.

Now, the 3Ds are building a fertile ground for a return of market volatility, acting as a trigger for a pause in the equity rally and for relative value. This means that investors should stick to some key convictions:

• While staying overall neutral on equity, it is wise to have protection in place.?Given negative real rates for bonds, equity remains the key alternative – even more so if bond yields are set to rise less than inflation, manipulated by policy actions, and dividends remain well-sustained. In the short term, investors should be prudent and build some hedging in case of a fast deterioration of economic conditions due to the virus cycle. Also, we can expect that the extraordinary earnings growth this year will not be repeated. Companies have been able to broadly pass on higher costs to consumers, but if – as we believe – inflation is going to be less temporary than expected, higher wages will follow. This has not yet materialised. While at regional level we keep a neutral stance, we recognise that on a valuation basis, Europe is more appealing, as it has not yet reached the peak in terms of growth and policy action is still supportive.
• The equity value call is intact, despite the summer weakness.?This is giving investors a second chance, if they had not embraced the trade in November, to enter a multi-year trade. The first leg was primarily a cyclical value call; the second wave could be more supportive for interest rate-related names (banks/financials) and prove beneficial to companies with attractive valuations (energy in the US).
• A short duration stance remains the name of the game in Fixed Income.?The search for income continues to favour peripheral Europe, IG and HY global credit, including Chinese bonds. The high level of leverage is an area to pay attention to for credit, which should be monitored based on a perspective of higher rates. This makes the case for selection at the corporate level paramount.
• We stay neutral overall in EM equities, but see divergences.?Short term, we are more cautious on China amid the regulatory wave while we are constructive on India and Brazil, where the worst of the Covid crisis is likely now behind us. On China, we retain our long-term positive call and believe that recent weakness has opened up interesting opportunities. Investors could take advantage of the selloff to increase their allocation in Chinese equity in global portfolios and manage the current phase focusing more on the sectors that are insulated by changes in regulation, such as biotech and clean energy-related stocks. On EM bonds, a key engine of income, the view is still cautious. The perspective of Fed tapering makes us prudent on duration, favouring HY, as well as on some idiosyncratic stories that need to be monitored (Cambodia, Thailand, Peru, Chile, Brazil) for political risk.

In conclusion, we reiterate the need to stay vigilant, on the one hand, but not become overly pessimistic, on the other. Markets are balancing less brilliant news from the economy with policy action. All this means that scrutiny of investment cases should be high, as there is little room for mistakes at current market valuations.

Please see: https://research-center.amundi.com/article/global-investment-views-september-2021