Investment Strategy

Continued call for caution

29 July 2020

 

ABN AMRO continues to take a cautious stance towards markets. Equities remain slightly out of favour (small underweight), while there is an overall neutral allocation to bonds - balanced between a preference (overweight) for emerging-markets bonds and investment-grade bonds at the expense of core government bonds (underweight). Most recently, the allocation to investment-grade corporate bonds was further strengthened, through a reduction and eurozone periphery government bonds.

While the coronavirus crisis is in no way behind us, the world is making progress in dealing with it. In many cases, countries have undertaken actions to successfully contain the virus and to establish protocols to keep populations safe. In general, China is in the lead in terms of dealing with the virus and beginning to stage an economic recovery, followed by Europe and the US. After a cautious reopening, China’s manufacturing sector, for example, is returning to pre-corona levels. Even in Hubei, the original epicentre of the virus outbreak, there is production growth.

For Europe, the key will be to learn from China and to avoid the mistakes now seen in the US. The base-case scenario, which has been informing our investment outlook, calls for a slow and protracted European recovery. There is the risk of a second wave of infections and renewed lockdowns – although probably with fewer restrictions than seen before. Second-round effects, including high unemployment, corporate defaults, tightening financial conditions and supply-side disruptions, are expected to delay the ultimate recovery of the global economy until 2021.

The US is now the epicentre of the pandemic, responsible for around 25% of infections worldwide. It is likely that it will be a long road back to low infection rates in the current ‘hot spot’ states (California, Texas, Florida) – and perhaps as long as two months. This will weigh on economic activity locally and perhaps have wider repercussions as well.

Second-round effects versus positive developments

Second-round effects, such as high unemployment, are becoming apparent, but can be temporarily overshadowed by the momentum of reopening economies. Other bright spots include the agreement of an EU pandemic recovery fund, which provided a boost to European markets. It establishes a EUR 750 billion emergency fund for distributing grants and loans. The fund will be a big help to reducing lasting economic damage and is a positive step to establish a more united monetary and fiscal European Union. In the US, a new fiscal stimulus plan is being hashed out, which could include another round of direct cash payments to consumers.

Some data, such as US consumer spending and confidence, has been better than expected. While retail segments, such as restaurants and travel & entertainment, continue to suffer, US retail sales in June were very close to the pre-pandemic levels of February. But despite these breaks in the clouds, our base-case scenario for economic growth in Europe expects GDP of -6.9% in 2020, recovering to 3.2% in 2021; and for the US economy to see economic growth of -4.8% in 2020, with a recovery to 3.4% in 2021. Another negative factor on the horizon is the possibility of tensions between the US and China.

Stocks remain slightly out of favour; bonds at neutral

Given the continued uncertainty, the overall asset allocation was left unchanged at the latest meeting of the ABN AMRO Investment Committee. Stocks continue to be slightly out of favour. This is based on the expected negative consequences of the after-effects of the first wave of the virus as well as the current high valuations seen in equity markets, which appear disconnected from long-term fundamentals and earnings outlooks. Earnings growth around the world remains under pressure. In terms of regions, the US (overweight) continues to be preferred over Europe (underweight).

A neutral stance continues to be taken to bond markets, although within the fixed income portfolio, an adjustment has been made to be more in favour of investment-grade bonds. This was possible by reducing the position in eurozone periphery government bonds after a rally. Yields on investment-grade bonds are attractive and will be supported by the purchases of central banks. We believe that possible weakening in corporate fundamentals has already been priced-in. Moreover, most investment-grade companies should be able to adjust to current market conditions and stabilise their results. The ECB is on board to continue buying enormous amounts of corporate debt for months to come, with asset-purchasing programmes totalling around EUR 10 billion per month. This will simultaneously support the asset class and drive spreads downward.

A call for continued caution

We believe that the unprecedented situation of a worldwide pandemic and the uncertainty generated from economies emerging from lockdown periods warrant a cautious approach to investing. Our subdued short-term outlook is based on the expectation of second-round effects from the first wave of the virus and the potential for it to surge again. While there is positive news regarding vaccine trials, inoculation is still far away and will not likely occur until 2021. Markets will therefore continue to be volatile and uneven, with risks to the downside. Over the longer term, we are more optimistic, and we retain our belief in the potential for risky assets to generate returns for investors.

Richard de Groot, Chair, ABN AMRO Investment Committee

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