H2 Outlook: Post Covid-19 recovery signals a more complex market
As we emerge from the Covid-19 shock, we expect market developments to eventually become more complex. In the next few weeks, the easy part of a post Covid-19 recovery will be over and by then credit and equity will be far more expensive. As we move to the next phase, we suggest adding flexible solutions to rapidly re-allocate capital either via a portfolio manager or an automated solution. Two secular themes though remain: 1) An economic rebound in China spreading to Asia Pacific, and 2) The ESG theme, which is increasingly becoming a core priority for investors, both young and old.
Two secular trends emerge
Covid-19 hit the global economy like a hammer with both supply and demand seeing shocks the likes of which we have rarely seen in over a century. Measures taken by the authorities in terms of health, support for workers and companies as well as aggressive monetary policy easing have helped temper the shock and initiate the recovery. We are now in the midst of what many expect to be a U-shaped recovery, which recent evidence suggests might be a tad quicker in the United States. The question beyond this is whether authorities have managed to stabilize long-term growth expectations which drive many long-term and short-term behaviors. Aside from Italy, government initiatives seem to be working quite well, giving us an encouraging picture of the future. The consequence has been a rally in credit and equities with the S&P500 close to all-time highs. What happens next though is more complex.
We expect the overshoot in equities to continue driven by the very aggressive monetary policy easing of central banks, fiscal expansions (including a second package in the United States) and the continued re-opening of the global economy with some temporary setbacks. One way to position for this is through Climate Funds, which typically load on second tier growth stocks. In the final phase of recovery, we could likely see an outperformance of growth and quality stocks versus value and cyclical stocks, which are more reliably valued by short-term valuation metrics such as the forward price to earnings ratio. This suggests a tilt towards growth and quality and, given the rising concentration of risk, we would suggest increasing strategies that can easily adapt to market regimes either through machines or portfolio managers.
Going forward, look for two secular themes to emerge. The rebound of the Chinese economy, should happen earlier than others, spreading to the rest of Asia over a period of one to three months. Here, we are focused on a rising middle class as well as a rich and innovative IT sector representing companies from search engines to microchip manufacturers. This can be exploited via EM equities or Bonds. Within Bonds, spreads have tightened considerably, but there are still idiosyncratic opportunities for bottom-up analysis and the odds are high that the Fed will adopt yield control (roughly 40%) and negative interest rates (roughly 60% though none expected by the market). Such a Fed policy would benefit hard currency and local currency EM bonds in countries heavily linked to the dollar. EM equities and bonds remain quite attractive to us as long-term investments.
The second secular theme, Environment, Social and Governance (ESG) investing, is likely to come even more to the fore as a crisis typically brings great changes with it, and more investors are waking up to the urgency of climate change. The status quo is increasingly being rejected and the resulting cultural changes will drive investment flows and prices. The advantage of ESG is that it typically reduces downside risks as the companies in this space tend to be better managed. Quality also often translates into performance.
The last phase of the post Covid-19 recovery will offer significant opportunities over the next two months. Beyond this, the environment is likely to become more complex from managed and automated solutions to the emergence of China and ESG. We define ourselves by our outlook and our risk management — the two likely will be important factors going forward.
Note: This is a NAM macro view, not the official Nordea view.