Investment Outlook July 2021

Global economic acceleration is broadening, with Europe joining the USA in the upturn. Emerging markets overall are lagging, with large regional differences due to differing virus situations and policies. Global industrial production is set to remain strong as inventories need time to rebuild. In the latest meeting, our investment committee confirmed our existing views on the major asset classes. We decided to maintain tactical allocations, including keeping overall equities as well as corporate credit markets at strategic levels. Government bonds remain at an underweight allocation.

In the following table, we present our view on the most important asset classes:

Market Views Overview

 very unattractiveunattractive        neutral               attractive         very attractive    
 
Global Fixed Income     
  Government Bds     
  Corporate IG Bds     
  High Yield Bds     
  Emerging Market Bds     
  Convertibles     
 
Global Equities     
  US Equities     
  Eurozone Equities     
  UK Equities     
  Swiss Equities     
  Japanese Equities     
  Emerging Market Eq.     
 
Foreign Exchange Rate     
  EURUSD     
  USDCHF     
  EURCHF     
  Emerging M. CCY     

The terms attractive / unattractive describe the return potential of the various asset classes. An asset class is considered attractive if its expected return is above the local cash rate. It is considered unattractive if the expected return is negative Very attractive / very unattractive denote the highest conviction views of the BENDURA Investment Committee. The time horizon for these views is 3 - 6 months.

Fixed income

Government Bonds

Continued fiscal support, vaccine rollouts and reopening of economies in many regions will continue to bolster the expected economic rebound. As a consequence, long-term global yields should continue to be supported. The recent bond rally amplifies the potential for this.

Despite the economic rebound, increasing prices and the change in the Fed’s rate projections, we think short-dated yields are set to remain anchored for the time being, thanks to the Fed’s revised average inflation targeting framework. However, there is a risk of increased monetary uncertainty, not only with respect to rates but also with respect to reduced asset purchases (tapering).

We reiterate our preference for short-duration strategies in the Eurozone and Switzerland. In the USA, we prefer the mid-term segment (5-year range) after the strong repricing earlier in the year. We stop favouring inflation-linked bonds over nominal bonds due to elevated breakeven inflation rates levels.

Investment Grade Bonds

We maintain our neutral outlook on global IG against a backdrop of reflation and potential further smaller central bank balance sheet tapering. In addition, we prefer to position for carry rather than capital appreciation. Spreads continue to remain expensive, especially in CEMBI IG which has limited tightening potential. We turn neutral on EM HC IG corporate bonds and see limited spread tightening potential; instead, we prefer to enhance carry and diversification by adding floating exposure where spreads are less expensive.

As a sub-asset class, we continue to favour European hybrids whose spread is less expensive than the US and European IG and still offer value pick-up.

High Yield corporate Bonds

We no longer expect DM HY to deliver an attractive carry return. Within HY-Bonds we therefore continue to favour Coco-Bonds.

Emerging Market Bonds

Our Investment Committee maintains its neutral absolute view on emerging market hard currency bonds, to reflect the lack of value after a strong spread tightening post March sell-off.

Going forward we see less support from technical factors given the slowdown in both institutional and retail flows together with the pick up in bond supply. The fundamental picture has not changed materially. Inflation remains a near-term risk, but most EM central banks have adjusted policies to mitigate the impact of price pressures on inflation expectations.

The Emerging Europe, Middle East and Africa (EEMEA) remains our preferred region. China is our preferred country, while Brazil is our least preferred country.

Selected Fixed Income Indices, YTD. Source: Bloomberg

Equities

We maintain global equity at a neutral level. Ongoing strong economic growth is expected to lead to further strong earnings growth, which should reduce currently elevated price-to-earnings ratios and make them look less demanding over time. Despite the renewed rise in COVID-19 infections in developed market economies, progress in vaccination efforts should significantly limit the impact of further outbreaks on economic activity going forward. However, recent market advances have become increasingly concentrated, implying reduced breadth of market gains. Tactical indicators and survey data continue to point to elevated investor optimism, suggesting the risk of a temporary market reversal. Therefore the Investment Committee has refrained from moving to an outright overweight in equities in portfolios at this time.

Key risks to global equities are a peak in economic growth and liquidity (a tightening of monetary and fiscal policy). Other risks for global equities include higher and more persistent surges in inflation, regulatory tightening, the Biden administration’s plans to raise taxes – which will likely be a headwind to earnings – and COVID-19 related developments such as renewed cases, further mutations or issues in the vaccination progress. Lastly, geopolitics remains an overhang as well.

Developed market equities

We expect attractive returns from developed market equities and have a preference for the UK and Germany. UK equities offer an attractive valuation coupled with an appealing dividend cushion, and also benefits from favorable sector composition. German equities offer further rebound potential, as the market’s cyclicality comes with some quality.

In sectors, we have a preference for Materials and Financials, while consumer staples and listed real estate are least preferred. Materials offer appealing fundamentals and should benefit from infrastructure investments. Financials offer further catch-up potential, as they are still attractively valued and should be a major beneficiary of an economic re-acceleration and once yields pick up again.

Emerging market equities

We continue to expect attractive returns from emerging market (EM) equities. However, we keep allocation at strategic levels in a portfolio context as near-term market focus shifts to peak growth worries and central bank tapering comments.

Key risks to our attractive view on EM equities are a stronger USD, abrupt tightening in financial conditions, spike in inflation, slow progress in vaccination and an escalation of tensions between the USA and China.

We continue to expect EM Asia to outperform global EM, given its strong fundamentals, exposure to chip manufacturing and sensitivity to pick up in global trade. EM Asia continues to offer strong earnings outlook and diversified exposure with sensitivity to global trade and recovery.

Selected Equity Indices, YTD. Source: Bloomberg

Currencies

At its June meeting, the Federal Reserve (Fed) suggested some changes in the perceived lift-off period for interest rates, with more Fed members suggesting earlier rates hikes than in March. The outcome was a slightly hawkish surprise and helped lift both US front-end rates and the USD. With short USD market positioning elevated until recently, we expect the USD to find some support in the very near term. In particular, lower-yielding currencies such as the EUR, CHF and JPY might be subject to further consolidation against the USD given the Fed’s changed rhetoric. We maintain a neutral outlook on the USD against lower-yielding currenciessuch as the EUR, CHF and JPY.

Global backdrop still positive for riskier FX: Despite the Fed’s shift and some likely cooling in leading indicators, global growth prospects look solid, with growth expected to be above trend for the next few quarters. We think this should still warrant a pro-cyclical bias. Our current preferred expression for this bias is long positioning in the CAD, NZD and NOK. Moreover, and despite an expected cooling in commodity price gains, these currencies have lagged the recent surge in commodity export prices, as reflected in commodity terms of trade, and should continue to benefit in the current macro environment.

We mantain our constructive view on the EM FX complex: EM FX declined from their recent highs over the last month given USD strength against especially high-yielding EM currencies. We have seen an acceleration in EM central banks’ hawkish shift in response to higher inflation. This is particularly true in Mexico, where the central bank surprised the market with a rate hike last month, as inflation was consistently above expectations. In addition to that, the fundamental picture in EM remains solid with strong trade and external balances, which should keep the asset class well supported. We continue to see further appreciation potential for the broad EM FX complex versus the USD and the cyclical exposure EM FX is offering as attractive.

Within EM, we continue to hold a preference for Asia. We remain of the view that a flattish mediumterm trajectory for the USD will leave Asia’s strong trade fundamentals to drive a gradual decline in USD/Asia, especially in North Asia. We thus remain positive on the CNY and the KRW, with 3M and 12M forecasts for the USD/CNY at 6.33 and 6.30, while those for the USD/KRW are at 1115 and 1080. The sharp fall in China’s PMI new export orders is a concern but trade data and global economic conditions point to continued support for the trade surplus.

EURUSD Rate, YTD. Source: Bloomberg

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