Multi-Asset Solutions Monthly Strategy Report
Global markets and multi-asset portfolios
EXHIBIT 1: MAS ASSET CLASS VIEWS FROM SEPT STRATEGY SUMMIT
Post-election market fundamentals support risk assets
What a difference a few weeks make. In late October, U.S. and European equities suffered their worst spell since March and credit spreads widened sharply. Fears about the potential economic toll of surging coronavirus cases and uncertainty about the U.S. election weighed heavily on market sentiment and sparked a surge in volatility. In November, by contrast, markets have swung to the positive end of the spectrum, with equities rallying across major markets and credit spreads tightening rapidly.
With a reasonably clear outcome from the U.S. election (including the almost certain inauguration of Joe Biden as President and continued Democratic leadership in the House), the political risk premium appears to have collapsed. Case in point: The VIX index fell from around 40 at the start of the month to the mid-20s range of recent days. While control of the Senate will not be known until early January, when run-off elections for the two Georgia seats take place, a split government seems the most likely outcome at the moment.
This state of affairs, if it prevails, should prove supportive for markets over the medium term. A Republican-held Senate would likely block certain initiatives that might have been less market-friendly, such as a partial rollback of the 2017 corporate tax cut. Meanwhile, we expect the incoming administration to strike a less confrontational tone in matters of international trade. In particular, we expect a Biden administration to pivot away from tariffs as the main policy lever, avoiding significant spats with traditional allies like Europe and facilitating normal operations at the World Trade Organization, and perhaps seeking to rejoin other multilateral agreements such as the Trans-Pacific Partnership.
As for regulation, the White House also enjoys some autonomy with respect to regulatory policy, but we expect fairly moderate near-term change in that area. Banks, for example, seem to be much less in regulators’ sights than they were in the aftermath of the 2008-09 financial crisis, although significant uncertainty surrounds the future regulatory model for large technology firms. Pre-election we thought that unified government would more easily facilitate another round of fiscal stimulus. But we have recently heard encouraging voices from within Congress discussing the possibility of at least a limited fiscal package in the coming weeks, and we expect there to be some connection between near-term worsening in virus data and congressional willingness to act.
Good news and bad news on the virus and vaccines
In the wake of the election, market participants appear to have shifted their focus back toward medium-term fundamentals, dominated by continued strong macro data and contrasting developments on the virus and vaccine fronts. Virus news varies considerably across regions. New case counts have risen in Europe and North America, with emerging economies showing signs of improvement as a whole and North Asia standing out as a consistent bright spot.
In Europe COVID-19 cases have spiked sharply over the past couple of months, with many countries now experiencing more daily cases than during the first wave in the spring. As a result, many governments have re-introduced social mobility restrictions and partial business closures. Still, we expect less disruption to economic activity, especially in goods sectors, compared with the first spring wave. Factories, construction sites, offices and schools will remain open. But we see signs that Europe’s services sector, already contracting, is feeling the pressure. In October, before most of the new government measures came into place, the euro area services PMI fell further into contractionary territory, pointing to ongoing weakness in the sector (Exhibit 2). Encouragingly, case counts appear to have improved at the margin in France, Spain and Germany, suggesting some possibility that restrictions can be eased before year-end.
Rising cases are weighing on euro area services
EXHIBIT 2: EURO AREA MANUFACTURING VS. SERVICES PMI
In the U.S., the virus picture has also taken a turn for the worse. Daily cases have continued to rise well beyond the pace observed earlier this year, affecting wider swaths of the country. In response, state and local governments have tightened some restrictions on activity, although thus far the moves have been modest, mostly focused on limiting restaurant capacity and the like.
Meanwhile, the virus situation in North Asia seems to be largely under control. In particular, daily new domestic cases in China have dropped back to single digits despite mini-outbreaks in several cities. This has enabled a broadening of China’s economic recovery, from the goods to services sectors. At 55.5, the October services PMI stood at its highest level since June 2012.
Weaker link between rising cases and bad economic outcomes
In general, the links between rising case counts and bad economic outcomes appear to be weaker compared with early this year, suggesting the deteriorating virus status has a more limited effect on activity. Fatality rates have moved up alongside rising case counts in Europe, but they are still well below their March peaks. Amid generally less dire health outcomes, the connection with social mobility also appears to have lessened (Exhibit 3). Mobility measures have been largely stable in the U.S., while the decline in mobility across Europe has so far trailed what we observed during the first wave. Moreover, economic data through the end of Q3 surprised on the upside, signaling considerable economic momentum currently underway. Nonetheless, we now expect moderately negative GDP growth in the euro area and UK during 4Q, and we see some downside risk to our above-trend growth projection in the U.S.
EXHIBIT 3: U.S. DAILY NEW CORONAVIRUS CASES (per mn, 7d avg) AND MOBILITY (% CHANGE FROM BASELINE)
With the virus situation clouding the near-term outlook, news on the vaccine front has strengthened medium-term anchors of our positive outlook. Preliminary trials of two separate vaccine candidates have produced results suggesting greater than 90% effectiveness, much higher than market expectations. If the high efficacy of the vaccine proves true after mass distribution, a fairly rapid normalization of still-affected activities could occur in 2021, creating upside risk to our medium-term growth forecasts.
To be sure, before a vaccine is rolled out, we continue to see the need for ongoing, and possibly stepped-up, policy support as a bridge past near-term problems. Some uncertainty surrounds the fiscal policy outlook, as we’ve noted, but we believe major central banks are prepared to roll out further stimulus. In recent weeks, the Bank of England and the Reserve Bank of Australia have expanded their quantitative easing (QE) programs, and the European Central Bank signaled it is preparing more easing measures for its December meeting. The Federal Reserve has also indicated its willingness to modify its asset purchases to make them more stimulative.
Coming out of our September Strategy Summit – the quarterly outlook gathering of our global multi-asset investment and research teams – we adopted a moderately pro-risk tilt in portfolios, while remaining mindful of ongoing tail risks. The “tick chart” (Exhibit 1, front page) that captures our broad preferences over a 6-to 12-month horizon reflected that orientation. While we made marginal shifts within portfolios at our October and November monthly allocation meetings, they remain well aligned with the September Strategy Summit views.
Macro data have generally matched or exceeded our expectations, supporting our positive base-case view of abovetrend economic growth through 2021. The virus resurgence poses a key risk to our growth outlook, but so far we are not seeing evidence of a broad-based double-dip, at least outside of Europe. On the other hand, a quick and successful vaccine deployment presents upside risk. Overall, then, we believe the continued economic recovery and persistent policy easing support the prorisk tilt in our portfolios. We maintain an overweight to equities and credit across our portfolios and are generally positioned to favor a weaker dollar. The recent sharp decline in implied volatility should represent a continuing tailwind. That said, we think both positioning and valuations across risk assets have become more stretched in the past month, pointing to fairly modest expected returns. Meanwhile, our qualitative views on duration have moved toward neutral, given the modest backup in yields, fading probability of aggressive multi-year fiscal stimulus in the U.S., and the promise of more asset purchases by central banks. Our quant models, though, remain strongly negative duration given low yields.
In equities, we continue to prefer a diversified exposure to different regions, across the U.S. (notably small caps, which our quant models favor), European and emerging market (EM) equities. More predictable trade policy actions under a Biden presidency with less emphasis on the use of tariffs will likely support Europe and EM equities. At the same time, the positive vaccine news is supportive of value stocks, favoring Europe and Japan and to a lesser extent emerging markets. But it is difficult to see a sustained value rotation without a greater rise in bond yields.