The great market detachment from reality

Monday 25 May 2020

Global Investment Views, Equity, Fixed income

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Contributing Authors

Pascal Blanqué
Group Chief Investment Officer,

Vincent Mortier
    Deputy Group CIO, 

The dichotomy between the false market tranquillity and the high level of uncertainty about the length of the crisis and its long-term implications is striking. In our view, we are far from being out of the woods and investors should stay alert as current market levels are still pricing in a ‘too rosy too soon’ endgame. The race between the three cycles will continue. On the pandemic cycle, markets have been relying on the narrative that the worst may be behind us in Europe and the US, with rising expectations of contagion curve-flattening. If these hopes are not realised, market tensions will resurface. On the economic front, the huge fiscal and monetary measures are like an insurance policy for the next six months, but should the recession prove worse than expected, markets will need more and any disappointment will trigger a correction. ‘Credit’ is becoming addicted to CB action; market conditions have improved but not normalised. On the credit default cycle, critical in a world that will see even more debt after the Covid-19 crisis recedes, markets have already priced in a first round of defaults but not a second one for traditionally laggard assets. The battle between liquidity and solvency will continue and US commercial real estate is an area to monitor. The disconnect between market hopes and economic and pandemic reality reinforces our conviction that now is a time to remain cautious: don’t chase the bulls, but gradually and selectively play investment themes better positioned towards a slow road to recovery. Reasons to be vigilant, on top of the uncertainties in the three cycles mentioned above, are: First, a resurgence of the US-China rivalry, amid the ‘blame for the virus’ game, was the main risk that re-escalated in May. Second, the outcome of US elections is uncertain. Third, EM are facing high idiosyncratic risks (Brazil). Finally, the long-term consequences (retreat in global trade, rebalancing of policies in favor of labor, transformation of business models, and acceleration of trends, i.e. smart working) of Covid-19 are complex and remain under scrutiny. During the unprecedented last 3 months, our focus has been: the dual objective of protecting investment capital from any permanent loss and having room to add to emerging investment opportunities. This attitude remains unchanged and investors should focus on the following:

  • Liquidity: This is precious in managing transition from the deepest phase of the crisis to an uncertain recovery. The crisis has made clear that liquidity should be a key metric of portfolio construction, despite recent signs of improvement. In fact, the depth of liquidity in credit markets remains thinner and more expensive than prior to Covid-19. Investors should keep some liquidity for defensive and aggressive strategies, so they can reposition in some areas of market when opportunities arise.
  • Positive stance on IG credit: This should benefit from CB actions and the primary market can offer opportunities. However, investors should remain very selective at the sector and company level, focusing on good balance sheets and businesses that can withstand the economic lockdown.
  • Conservative risk exposure to equities amid further EPS growth revision: Any catalyst for improvement must come from a vaccine or a potential treatment because only these factors could trigger a permanent recovery and positive change in consumer behavior.
  • Cautious on EM in light of rising geopolitical risks, with opportunities to watch in credit as well as in Asian and Chinese equities, but the evolution of the China-US relationship is key (recent tensions could derail market sentiment). The credit market is discounting an aggressive rise in defaults, but investors should consider that many of the most troubled stories have already traded down to their distressed recovery levels and some are currently even restructuring. Investors should identify those companies that can successfully draw up a plan to emerge from the distressed status.
  • Covid-19 is an accelerator of growing importance of ESG: While the E and G will remain high on the priority list, the societal focus towards higher social equality, fair treatment of employees and care for their health will underpin the growing dominance of the S component. There will be greater scrutiny of the ways companies act in the interest of all stakeholders and the community. This will translate into a greater impact on stock prices of some ESG risk factors, which will provide opportunities for active managers, in both the equity and bond space.

Fixed Income: Credit quality is key

Contributing Authors

Eric Brard
Head of Fixed Income, Amundi

Yerlan Syzdykov
    Head of Emerging Markets, 

Ken Taubes
    Chief Investment Officer, US, 
Amundi Pioneer

Over the past month, we have seen a gradual improvement in market conditions after massive price and liquidity dislocation in March, but we are still not back to normal. Investors should remain cautious, continue to maintain sufficient liquidity, and be mindful of potential rating migration which could cause volatility in credit markets. On the other hand, they should try to make tactical adjustments in order to benefit from market events – for instance, if there are attractive issues in the primary market – without changing strategic convictions.

Global and European fixed income

We have an overall neutral stance on duration, with a constructive view on the US and cautious ones on Japan and Germany. Investors can take advantage of yield curve movements (curve flattening in US, Europe, UK; steepening in Japan). While we remain positive on Euro peripheral debt, we are more cautious but still constructive on Italy (strong investor appetite as €22 billion raised recently through BTPs). Concerns on German court ruling and increased debt burden are balanced by Franco-German proposal for a sort of 'recovery fund.' On credit, US IG (we recently became more positive on this segment) and EUR IG remain well supported by CB actions, but credit selection and quality are important to distinguish issuers who will make it through the crisis vs those that will become insolvent. We like subordinated financials, telecoms, pharmaceuticals and insurance, but are cautious on US energy. Bond issuance in the US has been concentrated in IG borrowers and on BB-rated corporates (Fed’s decision to include fallen angels and HY ETFs in its program). We have confidence in BB sector, but search for quality is key here. Activity in US HY has resumed (demand exceeded supply) but activity is muted in Europe. However, investors should exercise caution.

US fixed income

Securities and sectors with limited prospects for price appreciation, such as insurance-linked securities (which have delivered 2% returns YTD) and AAA consumer and commercial real estate securitizations, have been resilient and may provide opportunities to serve as funding sources for long-duration IG corporates and some HY credit at deep discounts. We remain positive on RMBS outside of the AAA-rated tranches, as their spreads grind tighter but are overly discounted. Being careful to maintain adequate liquidity, investors should hold positions in UST, TIPS and US government agency mortgage bonds, and cash. In addition, this is a time to consciously pare back idiosyncratic risk when liquidity and pricing afford opportunities. Spread tightening in leveraged loans may enable investors to exit BB names at prices near par, and improve liquidity and quality while extending credit duration.

EM bonds

We are mindful that the Covid-19 crisis is weighing on global growth and corporate earnings, with negative effects on EM outlook, pushing many countries into recession. We have been cautious on names dependent on exports, commodities and tourism. Portfolio hedges and liquidity remain important. On HC, we are positive, particularly on HY (Ukraine). There are opportunities in primary market to gain exposure to IG names at discounted levels (Mexico). We are cautiously constructive on local rates in Mexico and South Africa, and positive on Russia. FX In DM FX, we are positive on the USD and JPY, given their safe-haven status, and are less negative now on the CHF but cautious on the EUR and GBP. On EM FX, we are defensive. 

Equity: Low earnings visibility calls for caution

Contributing Authors

Kasper Elmgreen
Head of Equities, Amundi

Yerlan Syzdykov
    Head of Emerging Markets, 

Ken Taubes
    Chief Investment Officer, US, 
Amundi Pioneer

Overall assessment

As governments ease lockdown measures and the world gradually moves out of the Covid-19 crisis, we are likely to see ballooning government debt, low interest rates and economic growth, a rise in the importance of ESG (especially the S factor), growing inequality, political fragmentation and increased geopolitical tensions (US-China, EU unity). We observe a stark contrast between ‘market sentiment’ and ‘economic fundamentals’. While it is important to note that policymakers can provide short-term liquidity, the demand recovery also depends on fear and confidence. This in turn could still impact earnings and long-term corporate solvency. Investors are forced to navigate this situation with exceptionally low forward visibility in an environment with potentially a wide range of outcomes.

European Equities

Overall we urge caution, given the heightened level of uncertainty and deteriorating fundamentals. It is crucial to maintain process discipline, focus on stock selection, and ensure appropriate liquidity levels. We continue to favour balance sheet strength and believe investors should balance near-term risks with medium-term opportunities through extensive use of scenario analysis. Opportunities exist and we suggest investors to apply barbell strategy with exposure to attractive stocks in the defensive sectors (utilities, health care, consumer staples) on the one end and non-disrupted and discounted cyclical sectors (luxury, construction) on the other. In addition, identifying some structural winners in some accelerating trends, such as e-commerce, will be key in generating long-term returns. From a style perspective, there are selective opportunities within value in non-disrupted cyclical areas. 

US equities

US equities remain one of the best long-term asset classes in the world, and the outperformance continues to build in these conditions. We expect the market consolidation that started in mid-April to continue. In terms of convictions, we believe the winners will continue to win. Investors should avoid the sector/stocks that are under extreme shortterm pressure, including airlines, challenged retailers, cruise lines, high fixed-cost and lowmargin businesses, and commercial real estate. Instead, we think investors should focus on sector leaders with sustainable businesses in an ESG integrated approach. This approach proved to be right during the correction and we recommend investors continue to follow this path. Sustainable companies with market-leading positions win when market conditions are tough. Now is also a time for investors to marginally start adding cyclicality to their portfolios, as low volatility is overpriced. At a sector level, we prefer financials, communications services and industrials while we are cautious on consumer staples, utilities and materials.

EM Equities

We are focusing on countries at a later stage of the coronavirus cycle (China, Taiwan, Korea) and less vulnerable names within stories of resilient domestic growth and progress in structural reforms (EMEA, India). While there could be headwinds as global uncertainties remain, skillful bottom-up selection, a careful top-down assessment, and liquidity management can help investors weather the current storm. In conclusion, although we prefer to maintain an overall cautious stance for the time being, our outlook is constructive for EM assets in the medium term – as long as the risk of a second wave of infection does not materialise.

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