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Cross Asset Investment Strategy

A note of caution for the back-to-school season

Amundi Asset Management,  September 2020

CIO Views

A note of caution for the back-to-school season

The appetite for risk assets has remained strong over the summer lull. This summer season has seen both the confirmation of existing themes and the emergence of new ones. On the former, the decoupling between the real economy and financial markets has proved persistent. Another confirmed trend is that the virus is not over: the back- to-school test in September will be key. A sharp reacceleration of the virus cycle would hit the financial markets, leading to mounting expectations of additional support measures, and this would again drive markets. A W-shaped recovery would be the most likely scenario in this case. On geopolitics, the US-China confrontation has taken a new twist recently in the tech sphere. President Trump has to resist the temptation to break the trade deal, as this would be disruptive for the fragile recovery and markets, but he is likely to keep pressure high ahead of the elections. The Presidential race is still very uncertain and a Democratic sweep would be a market mover, possibly leading to higher volatility in the corporate sector. For investors, the scenario is uncertain, with asymmetric risks. Markets are becoming similar to their February conditions (high valuations and complacency). Many sectors are far from recovering to pre-crisis levels, many companies have been kept alive with subsidies and the level of debt in the system has ballooned. Risk assets are discounting additional stimuli, a near-term vaccine and any net positive benefit from Democratic policies. Any disappointment is a reason for caution, and all the more so with tight valuations. In terms of investment strategies, this means:

  • Investors should remain prudent, but not risk-off: Autumn and the above mentioned risks could trigger a reality check, or at least limit any further detachment between the real and the financial world. Monetary policy will remain the guiding light for the markets, with the Fed sending the message that it will do whatever is needed to support the nascent economic recovery. This remains key for supporting risky assets, although the bullishness we have seen over the summer is unlikely to persist. All the elements that supported the risk asset rally are slowing down: the additional fiscal expansion is unlikely to be comparable to the first time, the same is true for monetary policy and the early signs of a recovery could be challenged. As risks are elevated, it will be vital to hold well-diversified portfolios, with quality assets and adequate levels of cash buffers.
  • In risk assets, the focus remains selectively on credit and EM bonds: We remain positive on credit, with a note of caution for September in light of the heavy issuance in Europe and for bonds whose valuations are full. In Europe, financial and subordinated debt are the areas of focus, together with selective opportunities in TMT, energy and cyclicals. Euro peripheral bonds are also an area where we maintain a positive bias. In US, corporate credit is preferred, with a focus on carry. The US market also offers attractive valuations in securitised credit and value in subordinated and consumer ABS. In EM debt, spreads have continued to narrow, but are still far off their pre- Covid tights. The discrepancy is particularly large between HY and IG. We view the latter as increasingly expensive, while in HY we still see ample room for compression from current levels. However, a significant degree of selectivity is needed in EM and investors should be aware of idiosyncratic stories: Turkey’s looming balance of payment crisis in September/October (negative); the finalisation of debt restructuring in Argentina and Ecuador (positive); and the Belarus crisis, which may potentially affect Russia sentiment.
  • Valuation dispersion in equities may offer opportunities: Markets seem priced for perfection, but the valuation dispersion is extreme, offering investors selective opportunities to play the recovery. In Europe, construction materials is a fertile hunting ground as there are high barriers to entry and it is a key beneficiary of the Recovery Fund. Conversely, technology (software in particular), despite good structural growth, is not immune from the effects of Covid-19. Current valuations are extreme, suggesting that caution is warranted in this space. In the US, the divergence between the big five mega caps and high-growth large caps and the rest of the market is huge. This means investors should prepare for a leadership rotation, focusing on the high-quality value space. Equities are still more attractive than bonds, but the direction of interest rates is a key element to watch. Higher rates at the margin could challenge current valuations. On the rosier side, the US consumer balance sheet doesn’t look that bad and the savings rate has gone through the roof. The cost of financing debt doesn’t appear to be a problem, either, and real estate is now somewhat resilient and in better shape than expected.


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