Dubai: Even as the pandemic rages on in several parts of the world, economic data continues to keep hopes alive of an – albeit slow – recovery, but investors can’t write-off every kind of risk just yet.
“The global economy’s recovery from the effects of the pandemic continues, but investors face a number of risks in the coming months,” said Luca Paolini, chief strategist at Pictet Asset Management.
Economic recoveries seen worldwide have been a tale of two: While for some, things have improved much since the economy opened up again after the lockdown, for others, the situation is direr than ever before as several industries devastated by the virus then, continued to stay that way even now.
“Economic activity has been picking up in US, Europe and most rapidly in China, where output levels are back at pre-pandemic levels,” Paolini added. “Although monetary stimulus from central banks may be easing, it is sufficient to support demand for now, but this is not to say all is rosy.”
Post risk-prone September
For investors, this time of the year has often resulted in magnified market risks and narrative shifts, and September largely fit that plot. Over the past few weeks, equity markets peaked at the very start of September before experiencing their largest correction since the new bull market began.
“Investors have no shortage of risks to contend with – a resurgence of COVID cases, fears of a new round of lockdowns in Europe and a potentially disputed US presidential election next month,” Paolini said.
“In light of this, we have retained a neutral weighting in equities and bonds. We like emerging market and euro zone equities yet, due to the uncertainty regarding COVID-19 and the US election, we have sought some insurance by retaining an overweight on the safe-haven Swiss franc and gold.”
During the month of September, Wall Street’s tech-heavy Nasdaq especially sunk, dragged down by a slump in the heavyweight technology stocks that have powered the rebound.
US Fed moves drive sentiment
“Even after selloffs in some formerly high-flying sectors, not least tech, valuations remain expensive. Which is why we stick to our defensive tilt on sectors and remain neutral on the pricey US stock market and IT sector,” Paolini added. “How the coming months pan out will boil down to two key factors – the US election and how much fresh stimulus there is.”
Markets have slid after the US Federal Reserve pledged to keep interest rates on hold until inflation averages over two percent, while declining to provide any formal guidance on their plans for more bond buying, which especially disappointed many bulls, both on the equity and fixed income side too.
Aside from the Fed’s lack of policy detail, the disappointing progress on fiscal negotiations in the US has also weighed on stock markets. It seems wrangling between both sides of the aisle may scupper a deal before the US election and that is bad for the stalling economic recovery.
Wait and watch mode
“Complicating matters is whether the recovery is self-sustaining. There are plenty of indications that economies are in relatively robust good shape. What’s more, strength in retail sales in the US and China belies some of the gloom of sentiment surveys,” explained Paolini.
“Hence, central bankers will be watching closely for how much or, indeed, whether more stimulus will be needed for fear of overegging the recovery if the coming wave proves less damaging than feared.”
Interestingly, with traders being forced to watch and wait, a wobbling stock market may be part of the pressure required to get a deal done. The issue here is one of how much pressure, in other words how big a sell-off, is required. The current correction has generally been defined as a healthy one, but after the parabolic rise at the start of the summer, this pullback has the potential to get a lot larger.
View on safe-haven assets
“Equities have so far been supported by falling real bond yields and an acceleration of growth momentum – but with this sweet spot slowly disappearing, we stick to a neutral approach to risk, taking a barbell strategy of quality defensives, while avoiding low-growth markets and sectors like the UK, financials and utilities,” added Paolini.
When it comes to gold, after its prolonged rise to its highs in early August, the precious metal has started to trade lower in the following month after consolidating its gains over the last couple of months.
The rise in the dollar index and real bond yields after the Fed’s latest announcement has weighed on gold as well with profit-taking and the occasional liquidation squeeze also prompting lower prices. Record weak gold jewellery consumption is capping the gains as well.
However, experts add that an accommodative central bank reaction function should see plenty of bullish investors dipping their toes into gold, especially if the market mood becomes more volatile into the coming months.
Prospects on European markets
“In Europe, the prospects for corporate bond markets are more balanced. The composition of the region’s high yield bond market is less cyclical and less energy-heavy than in the US. The investment grade segment is, like in the US, supported by central bank buying,” Paolini further said.
“One difference, however, is that the European Central Bank has been in the market for much longer than the Fed, which means the effects of its intervention are arguably fully priced in. Furthermore, we are neutral on the prospects for the European economy – which in turn supports our neutral stance across the region’s credit markets.”
This is amid signs that the pace of Europe’s economic recovery has slowed to a crawl. Data released on Friday showed that UK economic output grew slower than expected in August, rising 2.1 per cent month-on-month, falling short of the 4.6 per cent increase forecast by analysts. In France, industrial production edged up 1.3 per cent in August, according to Insee, again below consensus predictions.
“In sovereign markets, we see strong potential in emerging market local currency debt - developing world currencies are around 20-25 per cent undervalued versus the dollar according to our analysis,” Paolini added.