Autumn in the financial markets

Investment Policy, October 2020

Autumn in the financial markets

Summer is over, and there is a hint of autumn in the air. Is that true of the financial markets too? The double comeback – i.e. of equity markets and economic growth – since the lows of early spring is giving way to a phase of volatility. On the one hand, we are seeing a resurgence of political and economic uncertainties. On the other, the main drivers of this year’s equity market rally – the leading US technology and communication stocks – have performed so impressively since the start of the year that profit-taking has become more likely. We have therefore adopted a more cautious positioning with a lower equity beta. 

The global economy now appears to have clearly recovered from the nadir recorded back in the spring. That said, we do not fully trust the current market consensus with regard to the economic and equity market outlook, which is optimistic. For one thing, the strong recovery of markets since the spring now has a fair amount of positive development going forward already priced in. As an additional factor, the global political situation has hardly become less complicated. There are plenty of tensions simmering, such as with Russia, between Turkey and Greece, and between China and the US. On top of this should be added the uncertainties over the US elections, which we will be analysing in detail in our next Market Comment (26 October 2020). However, the possibility of no clear winner emerging from the race to the White House could result in a spell of volatility for the US stock market lasting many weeks, just as we saw 20 years ago. This could be triggered by uncertainty over economic policy or indeed by protests and unrest. The Brexit saga also remains unresolved, with the result that sterling has once again shown itself to be vulnerable to downside risks. This has led to many other leading currencies become more volatile recently.

In an interview with the newspaper Finanz und Wirtschaft published on 16 September 2020, I put forward the view that US equities in particular have once again become susceptible to profit-taking. For that reason, we started taking profits on our US equity holdings when they were close to their peaks at the end of August 2020. The huge price rises of the leading US technology and communication stocks, which now make up some 50% of the NASDAQ and 25% of the S&P 500, mean that they now account for a high proportion of these indices, with the potential risk that such a concentration implies. Indeed, they now easily surpass the market concentration of 18% represented by the five leading US stocks back in 2000. The increase in the valuations of America’s leading companies makes the US equity market more sensitive to profit-taking than other regions. Swiss equities, in which we have an overweight positioning relative to other regions, are not only less expensively valued than US equities, they are also more defensive.

Given the various uncertainties that exist, we are focusing on equities that exhibit below-average market sensitivity.

Gérard Piasko, Chief Investment Officer

Bond markets are currently being driven primarily by the direction of the yield on 10-year US government bonds. For a number of weeks now, this has been pursuing a sideways trend. On the one hand, government bonds are in demand because of their “safe haven” function. In other words, the bonds of countries with a high credit rating attract a greater volume of international capital at times of geopolitical uncertainties (US elections, tensions involving Russia, China, Turkey) due to the perceived security they offer. This is logical enough, and one of the reasons why such bonds continue to have a place in asset allocation. However, a greater underlying reason is that whenever the world’s key central banks are faced with the immediate threat of an economic slump, they are likely to ratchet up their purchases of government bonds, therefore providing their prices with active support. However, due to their historically low yields, which in many cases are in negative territory, it is not government bonds we are overweighting but corporate bonds – albeit of good quality, i.e. with an “investment grade” rating.

The legislative draft submitted by Boris Johnson, which (among other things) seeks to amend the agreement with the EU on the Brexit transition period in respect of the open border between the Republic of Ireland (part of the EU) and Northern Ireland (part of the UK), has caused the British pound to fall by some 5%. As the UK economy has more to lose than the Eurozone in the event of a “hard” Brexit (the EU accounts for a greater proportion of UK exports than vice versa), there is still further downside risk for the UK currency. Where the US dollar and the euro are concerned, we have an essentially neutral opinion now. True, the US dollar could benefit from new global economic uncertainties due to a resurgence in the wave of coronavirus infections. However, the US elections are looming ever larger, and in the event of a double victory for the Democrats (the presidency and a majority in Congress by taking control of the Senate), an increase in US corporate taxes would be on the cards. This would weigh not only on US equities relative to other equity markets, but also on the greenback. Why? Because the growth of the US economy could then slow – and the value of the dollar is typically a mirror of the wider US economic trend.

As anticipated in our last issue of Investment Policy (26 August 2020), there has been a clear increase in volatility in commodity markets, particularly – as predicted – in the price of oil. There are a number of reasons for this. First, market participants are wary of the threat to demand from a renewed wave of coronavirus. Second, on the supply side an increase in US oil production has been evident for a number of weeks now. Over the summer, a decline in the supply of oil was clearly observed to have triggered higher oil prices. At the last meeting of the Organization of the Petroleum Exporting Countries (OPEC), the Saudi Oil Minister urged other member states to adhere to the lower production volumes that had been agreed – but recent evidence suggests commitment to these targets is wavering. We are expecting the uncertainties surrounding the oil market to persist, and hence an increase in volatility. In the metal markets, meanwhile, gold has been experiencing the process of consolidation that we flagged up eight weeks ago. The continuation of the long-term upward trend will also depend on the development of the coronavirus situation and the performance of the US dollar. We are retaining our strategic positioning in gold.

Conclusion: We are remaining cautiously positioned in view of the increasing autumn risks. This approach also means focusing on quality – in both the equity and the bond market. On the equity side, we are overweight in the defensive Swiss market, as well as in stocks with below-average (minimum) market volatility. Essentially this means a slight beta-adjusted underweighting of equities. On the fixed income front, we are overweight in corporate bonds with strong (i.e. “investment grade”) credit ratings.

Gérard Piasko

Gérard Piasko

Gérard Piasko is CIO and head of the investment committee of private bank Maerki Baumann & Co. AG. Before he was for many years CIO of Julius Baer, Sal. Oppenheim and Deutsche Bank.

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This publication is intended for information and marketing purposes only, and is not geared to the conclusion of a contract. It only contains the market and investment commentaries of Maerki Baumann & Co. AG and an assessment of selected financial instruments. Consequently, this publication does not constitute investment advice or a specific individual investment recommendation, and is not an offer for the purchase or sale of investment instruments. Maerki Baumann & Co. AG does not provide legal or tax advice. In addition, Maerki Baumann & Co. AG accepts no liability whatsoever for the content of this document; in particular, it does not accept any liability for losses of any kind, whether direct, indirect or incidental, which may be incurred as a result of using the information contained in this document and/or arising from the risks inherent in the financial markets.

Editorial deadline: 24 September 2020

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