Some profit-taking in US equities

Investment Policy, September 2020

Some profit-taking in US equities

Following the pronounced recovery of all asset classes over the summer, financial markets are now likely to be more swayed by the discussion over the prevailing risks. The higher probability of a coronavirus “spike” following the end of the summer holidays, combined with geopolitical uncertainties such as Sino-US tensions and the approach of the US elections, could loom larger in the minds of investors. The flood of liquidity unleashed by central banks as a form of insurance against a renewed weakening of economic data remains a positive. 

The global economic environment is basically encouraging, as there are now fewer regional divergences even though some country-specific differences remain apparent. For example, within the emerging markets the spread of coronavirus is a factor currently weighing more on Brazil than on China, which is exhibiting the best relative development. Viewed on a global level, the economic trend is predominantly pointing upwards. That said, we are expecting the vigorous economic recovery that set in following the easing of lockdowns (shop closures) at the end of the spring to lose some of its momentum, and for two reasons: On the one hand, the catch-up effect has already played out on the consumer spending side, while on the other the expectations of the majority of economists have now become much more optimistic, which calls for a degree of caution.

Equity markets have experienced a pronounced V-shaped recovery following the lows touched in spring, primarily in the US and China, whereas Europe still has catch-up potential. The spread of the virus also is under better control in Europe than in the US, where – New York aside – rigorous containment measures have hardly been consistently implemented. This is why another stimulus package for the US economy is needed as a form of quasi-insurance, particularly to combat the rise in unemployment. The impending US elections are a further imponderable: should the Democrats take control of the Senate as well as the White House, tax increases could once again impact on corporate earnings, which have recently been better than expected. As the relative valuation of European equities is more attractive and Europe is enjoying greater economic stimulus thanks to the EU’s recovery fund and the European Central Bank’s (ECB) ramped-up quantitative easing (QE) programme, we are now more attracted to European stocks, particularly those with lower volatility (“minVol”). For global equity markets, the continued supply of large amounts of liquidity thanks to QE – i.e. the reduction in long-term interest rates owing to bond purchases by the world’s key central banks – remains a positive factor. This phenomenon has the effect of keeping government bond yields artificially low, while at the same time increasing the valuation appeal of equities compared to government bonds. Less positive for equities is the threat of a second major wave of the pandemic, possibly involving further partial lockdowns, along with geopolitical uncertainties in connection with the looming US elections and tensions between China and the US.

Now seems like a good time to take some profits in US equities in favour of Eurozone and lower-volatility equities.

Gérard Piasko, Chief Investment Officer

In the bond markets, the anchoring effect of central bank activity is evident at the short end. In other words: As long as the key central banks are not even contemplating the possibility of rate hikes (as stressed recently by Fed Chair Jerome Powell), it is longer-dated bonds that will dominate developments in global fixed-income markets. Over the next few months, long-term yields are likely to be particularly sensitive to new information about inflationary developments and economic growth. Whereas weaker economic data would be positive for government bonds, any rise in inflationary expectations or in actual inflation rates could bring about a correction to the sovereign segment, which is expensive by historic standards. Government bonds also continue to serve as a form of hedge against equity corrections, but due to the record-low yields on offer they are less attractive than corporate bonds of high quality, i.e. those with an “investment grade” rating. Although high-yield bonds with lower credit ratings offer a higher yield-to-maturity than investment-grade bonds, they also come with higher risks attached. Overall, we believe investment-grade bonds retain their preferred status within global bond markets due to the greater support they are currently receiving from the Fed compared to earlier QE phases.

The principal debate in the currency markets revolves around the decline in the value of the US dollar. In our last issue of Investment Policy, we explained why we had reduced our dollar overweighting over the course of the year, thereby reaping attractive profits for our clients. The euro is currently in a stronger position than the greenback thanks to the expanded economic stimulus unleashed by the ECB’s QE programme and the EU’s recovery fund, which will provide an additional economic boost in 2021. Where USD-CHF is concerned, we currently see fluctuations of 3-6% in both directions as plausible. Although the US dollar is now technically oversold following the sharp sell-off, both the narrowing in the interest rate differential and the current uncertainty about the US election result have stripped the greenback of much of its earlier support.

Commodity prices will be particularly dependent on how demand develops. For the most important commodity, crude oil, global economic growth is the decisive factor. The international Energy Agency (IEA) has recently downgraded its forecast for oil demand, after the release of data revealing that global air travel in July 2020 was around a third of its prior-year level. The greater spread of coronavirus, particularly in the US, is the reason why the IEA is reducing its estimate of global oil demand by 0.5 million barrels a day for both, the third and fourth quarters of 2020. However, the supply side will also remain an important factor for the price of crude, with Saudi Arabia having recently ramped up oil production once again. For that reason, the next few months will probably see greater volatility in both directions for oil – and for gold, following its dramatic rise. All in all, therefore, a neutral position in both commodities would now seem expedient.

Conclusion: Following the significant price gains recorded, the US stock market now looks ripe for some profit-taking due to its historically high valuation compared to lagging Eurozone stock markets and lower-volatility equities. We remain slightly overweight on the fixed-income side via our exposure to investment-grade corporate bonds, whereas we remain underweight in liquidity due to the unattractive interest rates available (including now for the US dollar too).

Gérard Piasko

Gérard Piasko

Gérard Piasko is CIO and head of the investment committee of private bank Maerki Baumann & Co. AG. Before he was for many years CIO of Julius Baer, Sal. Oppenheim and Deutsche Bank.

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Editorial deadline: 26 August 2020

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