Investment Strategy

Corona virus effects continue to cause concern

Publication date: 28 October 2020

 

ABN AMRO is becoming less cautious regarding the investment outlook in general and stocks in particular. It has shifted from a modest underweight to a neutral stance toward equities.

Some of the negative factors and uncertainties that have hung over the market over the past months are slowly resolving or the outcomes are becoming more obvious. This includes the US elections, the possibility of a second US stimulus package and the course of the covid-19 virus.

This resolution is occurring against a background of continued support from governments and central banks, low interest rates for longer, the prospects for a vaccine against covid-19 early next year and the remarkable resilience seen in markets around the world.

In light of these events, the ABN AMRO Investment Committee is increasing the allocation to stocks by shifting its stance from underweight to neutral. Exposure to the industrials sector has also been increased at the expense of the energy sector. The allocation to bonds remains neutral.

Increasing clarity regarding elections, stimulus and the virus

The Trump presidency has been unconventional; and it is natural that the US presidential race would play a role in market sentiment. US elections are 3 November, and we believe that moderate Democrat Joe Biden will succeed Donald Trump in 2021. There is also an increasing chance of a blue wave, where Democrats take over the US Congress by becoming the majority party in the Senate and keeping hold of the House of Representatives. A united Congress and White House would give Biden more leeway to implement his plans.

We believe a Biden presidency will restore a more normal approach to foreign policy that could have positive effects worldwide. He also has a plan to fight climate change, supports renewable energy and intends to rejoin the Paris climate accord. Like Trump, he will take a tough stance towards China, but will likely seek allies around the world to further his goals. Biden’s large lead in national polls is also reducing the potential for a disputed outcome – which was another market worry.

Another piece of positive news for markets is that negotiations for a second US stimulus plan are again underway, although the timing remains uncertain. There have been advancements in the talks in recent days regarding a substantial package to help consumers, businesses and local/state governments. President Trump wants a deal to be done and House Democrats do too. The question is whether Senate Republicans will approve it once a final package is agreed. We do not believe that the delay threatens the US recovery, even if it does not come until after the elections.

Finally, even though there is a resurgence in covid-19 infections in the US and Europe, months of experience treating it have improved outcomes and a vaccine is on the horizon. Even though the presence of the virus is increasing, we continue to believe that lockdowns will be regional or piecemeal. There are a number of vaccines now in late-stage trials around the world; the consensus market view is that a vaccine will be validated in the first quarter of 2021.

Still not smooth sailing

This is not to say that it is smooth sailing from here. No, instead we expect market volatility to continue, driven by news flow related to vaccines, macroeconomic data and the US fiscal stimulus negotiations.

Our base-case scenario, which has been guiding our investment outlook since the beginning of the pandemic, calls for a turnaround (from negative to positive) economic growth in the eurozone and the US in the second quarter of 2021, with a further synchronised recovery through the year, based on fiscal and monetary stimulus and vaccination campaigns. But in the meantime, second-round effects from the initial stringent lockdown periods, including rising unemployment and increasing corporate defaults, are expected. We may see weaker economic momentum in the coming weeks, but expect it to pick up again in late winter. As investors, it is important to already position for the expected recovery in the second half of 2021.

Industrials for the recovery phase

Based on a slightly more positive outlook for stocks, we are also increasing exposure to the industrials sector (from neutral to overweight), because we believe it will recover at a faster pace than the market as a whole. Segments of the industrials sector, including construction, transportation infrastructure and rail & road building, are expected to benefit from infrastructure stimulus packages.

At the same time, we are reducing exposure to the energy sector (from neutral to underweight). We expect energy to underperform in the months ahead owing to factors such as overcapacity and Opec instability. The energy industry is also suffering from poor market sentiment due to well-known environmental issues. Sustainable investors should be reassured that most renewable energy companies, such as wind turbine manufacturers, energy storage and battery producers, are not part of the energy sector, instead they are predominantly found in the industrials sector.

We also prefer the health care sector, where vaccine efforts have increased positive sentiment, and we are negative on the financials sector, which will continue to struggle with low interest rates and loan losses as a result of rising defaults. The financials sector and the IT sector (which we moved from overweight to neutral last month) could also be targeted for more regulation by the Biden administration. For all other sectors, we take a neutral stance.

Bonds: from French to American government bonds

We maintain our neutral view on bonds. We also maintain our suggestion to investors to remain very cautious on government bonds. This is mainly due to low and even negative interest rates. Partly because of these low interest rates, we are now suggesting to investors – in portfolios where this applies – to switch from French government bonds to long-term US government bonds (EUR hedged).

European government bonds with negative yields should have acted as a buffer in times of uncertainty, such as the corona crisis. However, this buffer function has not had the desired effect – hence our suggestion to sell French government bonds and buy long-term US government bonds with the proceeds. Yields on long-term US government bonds still have room to fall further, and we expect that to happen in due course. As bond yields move inversely to prices, investors may be able to realise price gains in this way.

Conclusion

Over the past few months, the economic recovery has been much stronger than anticipated. This is owing to huge fiscal stimulus and resilient consumers. This combination fuelled better than expected macroeconomic data and a rebound in stocks. While there is no doubt that turbulent times remain ahead, some core concerns of the past six months are disappearing or are being replaced with more positive elements. We look ahead to 2021, when a potential vaccine will alleviate more worries around the world, while central banks and governments do all they can to foster a solid recovery.

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