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Chief Investment Officer's team, 18.10.2020
Global markets closed the week on a positive note, snapping a three-day losing streak following strong US retail sales and above-consensus earnings from European companies. Yet, in the five days through Friday the S&P 500 eked out only modest gains and Europe lost ground, on growing concerns about virus resurgence in the West and lack of additional stimulus from Congress. Although House speaker Nancy Pelosi and Treasury Secretary Steve Mnuchin are still holding talks on a possible deal, it would be difficult for lawmakers to “execute” a relief package before the Nov. 3 election, said Trump’s economic adviser Larry Kudlow. Lack of positive catalysts and the possibility of a contested election outcome should keep markets range-bound in the next few weeks. VIX futures still imply investor expectations for higher volatility to persist into November and even December.
President Trump and Democrat Joe Biden’s dueling town halls held Thursday highlighted their opposing approaches on major issues. The second and final presidential debate is going to take place Thursday this week in Nashville. Irrespective of whom the new Whitehouse tenant will be, the US-China relation is likely to remain bumpy to say the least. Mr Trump is not the only one concerned about China’s progress and Bridgewater founder Ray Dalio sounded the alarm again. He said that Beijing can count on multiple advantages, including a stronger economy and higher interest rates. He sees the coming internationalization of the renminbi as a threat to dollar dominance.
A choppy week was capped by Boris Johnson’s warning that the UK will get ready to leave the EU without a trade deal, blaming the bloc for the talk failure.
A consensus view is building that the US dollar is set to weaken on a multi-year time frame. This is plausible, considering that the drivers of large twin deficits and low policy rates are most likely going to be in place for years. The US trade deficit recently reached a 14-year high and the budget deficit is projected to skyrocket as more fiscal stimulus lines up. Growing deficits, weighing on growth, should be a lasting source of dollar weakness, especially on the fiscal front, now that more government spending is going to be financed by the Fed’s asset purchases. At the same time, the Fed recently announced that it is planning to keep policy rates low until average inflation will comfortably exceed its target level, which might not happen before 2023, at least. Since the tendency is for high-yielding currencies to be bought, and low-yielding currencies to be sold, or be used as funding currencies, the US Federal Reserve new monetary stance is going to be one more source of trouble for the dollar.
So far, so good for the longer term. Yet, on shorter time horizons it could all be looking a little different. Shorter-term drivers suggest that the US currency could selectively rebound against DM peers, irrespective of the outcome of the US elections. The mainstream dollar-bull case is represented by a Trump win, whereby a re-rating of US-centric assets would be taking place, with more “America First” and probably also some infrastructure expenditure further down the road, though on a less large scale than in the case of a clean Biden win. With a Democratic sweep, markets would be discounting a softer tariff approach towards China, obviously supportive of EM Asian currencies, but first and foremost large fiscal packages from the Democrats, stimulating the economy and eventually pushing inflation higher. Under this scenario there is the chance that US 10-year yields would be temporarily breaching the 1% mark, shifting the yield differential more in favour of the dollar. This would be playing all the more so out against the euro, the heavyweight in the US Dollar Index, since mobility in Europe is now starting to be hampered by virus resurgence and the strict countermeasures being taken by local governments. With time the dollar-negative factors would be reasserting themselves, but for the time being record positioning against the US currency could rather create favorable conditions for a dollar squeeze higher.
The outlook for gold should play out in exactly the opposite way. Gold should be range-bound into year-end as real yields try to put in a bottom following the recent sharp fall. As the possibility of large fiscal packages looms closer and real yields inch higher, gold will be weakening and providing investors with a buying opportunity.
Both a dollar rebound and a gold pullback currently might not be contemplated by many market participants, which should nicely improve the chances of this non-consensual view to unfold as expected.
Fixed Income Update
The bear steepening underway in US Treasuries is meeting speed-bumps, as anticipated in the previous issue of this publication. Markets met bumps last week with the expectation of a pre-election deal fading fast and European countries putting shutdowns into effect on increasing virus infections. The Treasury curve flattened slightly due to these rising concerns. The 10-year yield closed at 0.74, and the 30-year yield saw a five bps pull-back to trade at 1.53% last Friday.
The same pattern reverberated across sub-asset classes. Returns were flat-to-negative in High Yield and Emerging Market bonds, while Investment Grade credit spreads remained at 118 and the asset class delivered positive returns on lower Treasury yields. We believe that Investment-Grade spread tightening will continue even with some credit metrics looking historically elevated due to the higher borrowing levels. According to research by Goldman Sachs, the four-quarter moving average US-IG Net-Debt-to-EBITDA has reached 2.7. This is the highest ever recorded level since 1999. Interest coverage ratios have dropped significantly on lower EBITDA levels, though this is still better than what was observed for corporates in 2009.
According to S&P, the global default tally had inched higher to 189 as of 16th Oct. While missed interest and principal payments have lead corporate defaults so far in 2020, spread compression in summer helped refinancing opportunities, alongside distressed debt restructuring, distressed exchanges in financial jargon, which have increased in recent weeks. Distressed exchanges have lead the corporate default tally in the second half of 2020 so far, with 23, followed by missed interest and principal payments and bankruptcy with 18 and 15 defaults, respectively. At this point in 2009, 2016, and 2019, there had been 234, 135, and 90 defaults, respectively. By region, the US leads the global default tally with 124, followed by Europe with 31 and emerging markets with 25.
Fund flows into Fixed Income funds remained strong at $17.6bn last week, with most of the flows directed towards ‘global aggregate’ products, which cornered one-third of the flows. EM Hard currency funds also saw strong demand that resulted in $1.3bn inflows last week. Increased chances of a Biden presidency seems to be propping up the asset class.
GCC Fixed Income markets have continued their strong performance this month, taking MTD returns to a solid 1.71% compared to a MTD return of 1% for the broader Emerging Market index. Primary market issuances made a came back with three deals priced last Wednesday. CBD issued a perpetual NC6 bond with a coupon finalized at 6%. Tabreed sold $650 Mn 7-year USD bond priced at MS+215 bps and a coupon of 2.5%. Apicorp upsized its earlier 5-year bond through a tap of USD 250 Mn.
Gobal equities went through a choppy week with hopes of a Democratic sweep initially buoying markets, but an increase in coronavirus cases in India, Europe and some US states eventually dampening sentiment. It is again lockdown time in Europe, with France announcing night-time curfew in Paris and eight other cities and Germany announcing restaurants in higher-risk areas must close early. UK, too faces tighter Covid-19 curbs within days. This dashes hopes of a quick economic recovery, negatively impacting in particular the leisure and travel industry while keeping COVID winners well bid. On the Brexit front UK PM Johnson delayed a decision on whether to quit the Brexit trade negotiations until after the European Council summit, which concuded last Friday. Vaccine news remains mixed with trials under progress and Pfizer announcing may be ready to apply for emergency-use authorization of its vaccine as early as November.
Global equities have gained upwards of 5% year-to-date and shouldbe supported by further inflows from retail and institutional investors. BlackRock CEO Larry Fink said retail investors are transforming the global asset-management business, with the Covid-19 pandemic forcing people to rethink how they save and invest. Blackrock saw an increase in AUM to $7.8 trillion. We remain constructive on equities both from a top-down and bottom-up point of view. The gains in global indices continue to be driven by the tech, consumer and healthcare sectors and the shift to the digital economy. We also have the carrot offered by the beaten-down cyclical sectors in for quite a rally once economies start to recover. We remain cautious on the oil sector, both from the perspective of a Democrat win, where fracking may be targeted, and as global demand remains subdued. The Q3 earnings season could be overshadowed by election and coronavirus narratives. As US earnings season kicked off by the large banks, surprised to the upside, with the exception of Wells Fargo, although guidance was cautionary. Banks remain a bellwether for the economy and though valuations are attractive, share prices remain depressed weighed down by restrictions on dividend growth and buybacks.
The UAE markets saw gains in Abu Dhabi and the KSA last week. The Tadawul was supported by NCB and Samba, which rallied following the merger news. The merger would bring significant cost synergies to the new entity, which would become the 3rd largest bank in the region by assets.
In the latest bout of US- China tensions, a Reuters report states that the Trump administration is considering adding China's Ant Group to a trade blacklist. No timeline has been defined. This is just as the fintech arm of e-commerce giant Alibaba is set to go public with a $35bn IPO. Whilst China tech faces a backlash from the US, tech companies in the United States are under threat of an EU attempt to whittle down at their gatekeeper position. Brussels is drawing up landmark rules on regulating large online platforms, particularly big US companies, exploring measures allowing users to take their private data to a competing platform. Up to 20 companies could be hit with the new and far tougher rules under proposal.
Written By:Maurice Gravier Chief Investment Officer, MauriceG@EmiratesNBD.com
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Short-term uncertainty spikes
Known catalysts with an unknown timing
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