Our equity fan charts generally show markets rising as a central expectation, but with large uncertainty and a big downside skew, thanks to the severity of the downside outcomes. Our overall attitude is therefore cautiously positive towards equities, but expect judicious stock selection to be key.
We acknowledge the opportunity offered by US equity markets and suggest a balanced approach to cyclical sectors (Industrials, Financials, Energy) and higher growth sectors (IT, Health Care) as we expect cash to re-enter equities as economies continue to reopen.
Given interest rates are likely to stay low for a long time, dividend-paying equities are an attractive income generator and less volatile component of equity allocations. Small businesses have been hit hardest by this crisis, but fiscal support and the expectation for a rapid restart have driven sentiment higher, improving the outlook for small-cap stocks.
Europe faces fiscal headwinds that increase downside risks, but there is room for European equities to catch-up through 2020 as global demand comes back online and the region is supported by the expectation for a large fiscal support package.
EM risks have moderated recently as several major countries have started to ease lockdowns. The USD has shown weakening bias, and oil prices have started to rise again. Still, the macro environment for many EMs remains challenging and downside risks are present. As the pace of economic recovery will be countryspecific, EM asset performance will remain idiosyncratic.
Given the plethora of monetary policy and fiscal support, particularly in the US, we believe the risk of a spike in sovereign yields is limited and the US yield curve is likely to see a gradual steepening as the recovery ensues. This asset class remains an effective hedge against macro risks and despite historically low yields, still offers diversification value in the event of a downside shock.
Our new credit fan charts show the high-yield less investment grade spread most likely remaining in the 300-500bps range. There is a large upside skew, however this is somewhat smaller than the downside skew in equities. To an extent, that reflects a confidence that the Federal Reserve and other central banks can offset a credit crunch in all but the most challenging scenario (the ‘L’). Overall, this suggests cyclical credits can offer exposure to a recovery without presenting outsize left-tail risks.
Multi-asset strategies that utilize put options for protecting against swift downdrafts in equities, and those with the flexibility to quickly rotate into cash if one of our downside scenarios becomes increasingly likely.
We believe the market is currently underpricing inflation risk and investors can protect purchasing power with real assets and precious metals.