Quarterly Investment Outlook
Third Quarter

Created: 2020.07.10.

You will find below our quarterly market review for the second quarter and our investment outlook.

Market Review

Global markets were supported by the ongoing reopening of economies and signs of a robust pick-up in growth through May and June as restrictions were eased. A rise in new daily Covid-19 cases globally and particularly in the US resulted in large pullbacks over the course of the month. The virus has not been fully contained, nor a vaccine approved. In continental Europe and large parts of Asia, including China, new infections have fallen to low levels and economies are reopening. However, several emerging markets and the US have been unable to get the virus under control.

As economies started to reopen, economic data showed signs of a sharp rebound, though the coronavirus shock continued to weigh heavily on manufacturing, trade, and services. Fortunately, China's economy is in an uptrend led by a rebound in industrial activity and increased policy support. However, weak demand from the rest of world is likely to keep the recovery muted.

Government bonds were flat in US and Switzerland as investors turned away from safe havens. In Europe, the more noteworthy development was a decline in the Italian 10-year yield of over 0.22% to 1.25%. Eurozone bonds benefited from hopes of moves toward more coordinated support measures in the eurozone. Investment grade corporate bonds continued to be supported by Fed and ECB’s direct bond purchases.

High yield corporate and emerging market debt also posted a good month as investors assumed that the worst is over and became more comfortable with risk.

Global equities achieved one of their best quarter in 20 years with a 2.5% performance in USD terms in June. Gains reflected progress toward lifting lockdown measures globally and an initial rebound in economic activity that was quicker and stronger than anticipated. The S&P 500 was back only 8% below its February peak and the Nasdaq hit a record high on June 23. Markets outside US continued to rebound, EM equities outperformed over the month with a 7% gain.

The dollar index weakened by 1% amid rising risk appetite. Gold was a notable bright spot during June rising close to $1800, fuelled by lower interest rates, geopolitical uncertainty, and the unknown surrounding COVID-19.

Investment Outlook

The speed and durability of the economic rebound essentially depends on the virus. Uncertainty regarding the economic outlook remains high as long as there is no medical solution for COVID-19. The quality of crisis management with safety measures will determine how the recovery in different economic regions evolves. Massive fiscal and monetary stimulus will persist over the coming quarters to offset the economic fallout of COVID-19. In part as a result of this policy intervention, neither equities nor bonds nor cash seem to offer anything close to an attractive valuation these days. We believe this rally remains driven by liquidity rather than fundamentals. And if fundamentals do not catch up, we will certainly see bouts of rising risk aversion. A meaningful change in the health outlook for COVID-19 will lead to a great economic recovery but risky assets are already anticipating a rapid V-shaped recovery, making them vulnerable to disappointment on the earnings and pandemic front. A sharp rise in infections that results in a renewal of lockdowns, a labour market deterioration, and changes in consumer behaviours could trigger a new volatile market regime. However, economic impact should be more modest and fatality rate should be lower in case of a second pandemic wave.

We expect bond yields to remain low given the fabulous monetary policy support from central banks. In this low rate environment, investors will continue to hunt for yield. While valuations are not attractive and global indebtedness at record levels, high-quality fixed income will continue to play an important role in providing protection if the recession should deepen. We are also comfortable with an exposure in investment grade corporate bonds as central banks will continue to directly intervene. Despite spreads widening due to the downturn and central banks support, we avoid high-yield positions as defaults are inexorably likely to rise.

Profits have declined significantly during this downturn. S&P 500 earnings for the second quarter period are now seen plunging by 43.4% year-on-year dramatically worse than the 11.7% decrease expected as of April 1. However, profit declines are not experienced equally across all sectors. Areas like technology and health care have held up much better than areas like energy and consumer discretionary. Looking ahead, we need to see a recovery in earnings in Q3, higher earnings visibility as there is a limit to the re-rating in the price earnings ratio, which has driven the latest rally in the equity market. Thanks to our flexible strategy, we will adapt our exposure to reflect changing market conditions. We continue to focus on large cap equities from developed markets with a quality bias and elevated ESG scores.

We still favour gold, the Japanese Yen and Government bonds as protection assets in portfolios. With major global central banks assuring unlimited quantitative easing (QE) programs and promising to keep interest rates lower for longer, gold prices should continue their ascent close to the all-time high of $1891.